AAR Corp. (AIR) Earnings Call Transcript & Summary

All right, thank you so much, and good afternoon to everyone. I'm glad you could be with us today as we go over what we achieved in the first quarter of fiscal year 2021. Before I walk through the quarter, I want to once again say how thankful I am to the people at AAR. Through the entire pandemic, most of our workforce has kept showing up each day so that AAR could support its customers without interruption. Their commitment and dedication mean a lot to me, and I take pride in how our team has managed to keep steering through a downturn in commercial passenger flying that is genuinely without precedent. Now to the numbers. Revenue for the quarter fell 26%, going from $542 million down to $401 million, while adjusted diluted earnings per share from continuing operations dropped 70%, from $0.57 per share to $0.17 per share. Sales to commercial customers came in 48% lower than a year earlier, whereas sales to government and defense customers rose 10%, driven by new contract awards and sizable shipments from our Mobility business under the $125 million cargo pallets contract we announced previously. Government and defense customers accounted for 56% of total sales in the quarter. Given the current environment, we've carried out a range of measures to bring our costs in line with weaker demand, yet we've also gone beyond that to put the company in position for better margins once demand comes back. Across the past 3 years, we've consolidated 3 — or rather over 3 quarters, we've consolidated 3 facilities, we've made lasting cuts to both our fixed and variable costs, and we've exited or restructured a number of contracts that were underperforming; on top of that, we've taken steps to concentrate on our core aviation services offering by finishing the divestitures of our airlift and composites businesses. Every one of these moves has made our portfolio simpler, brought greater efficiency to our operations, and positioned us to generate stronger returns on capital. Alongside that progress, we kept winning new business in the quarter. We announced a 3-year contract with the Royal Netherlands Air Force covering repair of F-16 jet fuel starters. We also announced 2 new contracts secured by our Airinmar subsidiary, which delivers component repair cycle management and aircraft warranty solutions; both Frontier Airlines and Air Methods, the largest civilian helicopter operator anywhere in the world, chose us to supply a complete suite of warranty and value engineering services. Beyond the wins this quarter, we observed stabilization in some of our businesses. Order volume and trading and distribution held steady through the quarter, at a level higher than what we experienced in April and May, though still far under pre-COVID levels. In our MRO business, with fall approaching, the loading we anticipate in our hangers gives us encouragement. Our customers are still dealing with an uncertain environment and their maintenance schedules might shift, but the early signals look favorable compared with what we had expected earlier. We stay in continuous contact with our commercial customers around the globe and keep searching for ways to assist them through this challenging period. Regarding our government segment, which expanded during this period, we keep chasing fresh prospects, and that pipeline is still packed. Having said that, I'll hand things over to Sean Gillen, our CFO.

Appreciate that, John. As John pointed out, we kept taking steps during the quarter to bring down our costs and get out of activities that aren't performing well; those steps, along with some other items, produced pretax charges of $37.3 million that were mostly noncash. And, as we've already disclosed, we got financial aid during the quarter under the CARES Act. What we received in total came to $57.2 million, split between a grant of $48.5 million and a low interest prepayable loan of $8.7 million. During the quarter, we used $8 million from the CARES Act grant plus $3 million in other non-U.S. government labor subsidies, adding up to $11 million. That figure shows up in the GAAP income statement, though it's left out of adjusted earnings. When the quarter closed, the grant portion still unused stood at $40.8 million, booked as a current liability. That sum will move through the P&L as we use it, and we anticipate finishing that by mid Q4. Now for a few more financial details from the quarter. SG&A expense came to $45.3 million in the quarter. Adjusted for certain items, SG&A was $39.7 million, a drop of $10.5 million versus the same quarter a year ago, reflecting the shrinking of our overhead cost structure. Adjusted SG&A represented 9.9% of sales during the quarter. Net interest expense for the quarter was $1.6 million, versus $2.1 million a year earlier, reflecting the lower interest rate during the period. In the quarter, our continuing operations operating activities produced $39.8 million of cash; that includes the $48.5 million grant piece of the CARES Act funding plus a net cash use of $18.6 million tied to lowering the level of our accounts receivable financing program. If you set aside the effects of the CARES Act and the accounts receivable financing program, cash flow provided by continuing operations operating activities was $9.9 million. On top of that, since we've concentrated on bringing working capital down, we managed to cut inventory by $19 million in the quarter; we also paid back $355 million on our revolving credit facility during the quarter. We had drawn the entire balance earlier as a precaution. At the end of the quarter, our net debt stood at $149.3 million and unrestricted cash was $107.7 million. Our balance sheet is still strong, with net leverage of 1.1x, roughly $355 million of availability under our revolver, and no maturities coming up soon. Thanks for listening, and now I'll hand the call back to John.

Alright, thanks Sean. Given where the macro backdrop stands right now, we feel good about how Q1 turned out. Demand from our government segment is still solid, our cargo end markets keep producing interest, and our balance sheet is in a sturdy place. As we mentioned during the Q4 call, because of market uncertainty, we aren't offering guidance for the remainder of the year at this point. That said, when we look further out in a broader sense, even though the shape of the rebound is still unclear, we anticipate the aftermarket will bounce back more quickly than the OEM market. Inside the aftermarket, we believe used serviceable material — an area where AAR holds a leading global position — will be favored by operators ahead of pricier options; we also anticipate that additional material will come onto the scene to back this demand as aircraft get permanently retired and taken apart for parts. That factor, together with the maintenance deferrals happening across both airplane and engine, ought to fuel greater demand for services from our trading, distribution and MRO businesses as the commercial market rebounds. Although we don't know when the recovery will arrive, we think the steps we've taken and keep taking to right-size our cost structure and reshape our portfolio, paired with the caliber of our team, the airlines' appetite for cheaper solutions and our balance sheet, put us in a distinctive position to gain from demand eventually coming back and to come out as a company that's even stronger and more profitable. With that, I'll hand things back to the operator for questions.

I've got a few things to ask. You said you're encouraged and noticing some positives. John, could you discuss how volumes moved across the different businesses — mainly commercial as a whole — month by month during the quarter? And when you say that, should I take it that your outlook right now is more bullish than it was 3 months back?

Absolutely. Let me walk through each of the businesses. On the parts side — trading and distribution — order volume stayed fairly steady month to month across the quarter for both of those. MRO got better as the quarter went on; August, for instance, came in stronger than June. And heading into Q2, we anticipate MRO will rise above what we saw in Q1. When we say we're encouraged, what we mean is that 3 months ago, sitting here, we lacked clear visibility and, I'd add, held weaker expectations for the MRO loading we thought we'd get in the second quarter going into fall and winter. So far, what our customers are signaling is stronger than what we'd anticipated when Q1 started.

Can you put any kind of number on the MRO loading — a percentage, maybe, of how much of your hangar capacity you're using — for fiscal 1 compared with fiscal 2, and so forth?

In our view, we definitely examine it through the labor hours we turn out. Q2 is going to be a stronger quarter on that measure than Q1, though it will still sit well under the level we delivered a year ago. Past that, I'd rather not provide any specifics right now. What I can tell you is that, as you're talking with and hearing from every one of the commercial airlines, there's still a fair amount of movement out there regarding what they anticipate when it comes to demand. And certainly, the headlines over the last few days would suggest things are happening in Europe, et cetera, and people are asking questions about what might occur here in the U.S. That said, at this point we have pretty good dialogue and reasonable visibility into what we expect the second quarter to bring.

And in MRO, would that mirror the reduction in commercial volume that I believe was 48%? Looking at the hours for the first fiscal quarter, do they line up with that figure? Or is there another factor...

For MRO, I’d answer yes—it tracks along the same lines in Q1.

And that improves a bit in Q2?

Yes.

Are carriers getting ready for a traffic comeback during calendar year '21? Is that the reason behind your Q2?

Yeah. There is some preparation taking place for holiday flying. That's normally the thing that fuels demand during the fall. Then what we observe across winter and spring is preparation for summer travel. We're also noticing considerable activity among the airlines — on one side, they're looking to hold onto cash and stay cautious. On the other side, they don't want to be left behind if bookings do rise and they're able to bring on additional routes.

All right, and finally, you brought this up near the close earlier. You referenced how much USM matters and the rebound. Could you give us a bit more detail on the patterns you've observed? Have the owners and operators begun deciding to part out aircraft? When we last held this call, I believe they had not yet reached that stage. And are fresh buyers emerging for USM — ones who in the past chose not to buy used serviceable material?

Yeah. I'll take the second portion first. Yeah, we're receiving signals from customers who in the past wouldn't have had any interest in aftermarket material, particularly in Asia, and they now seem more open to it. And we do anticipate that becoming a trend. Returning to the earlier portion of the question, there appears to be a mismatch in the market between fleet reduction announcements and real retirements. Fewer real retirements have shown up than we'd anticipate by now. Consequently, we genuinely haven't seen as many aircraft entering part out as we'd anticipate by now, though we do expect that to come. Our balance sheet puts us in a highly advantageous spot, so when aircraft that interest us do begin to appear on the market, we'll be able to make those investments as soon as we gain a clearer picture of what the market will look like.

John, I guess I appreciate the somewhat muted confidence when it comes to giving guidance for the commercial side; however, you both point out how large a portion of the business is generated by defense, and clearly one advantage there is visibility. So might you lay out some structure regarding what you anticipate for revenue and gross profit on the defense side across the year?

Yes. Right now, we're looking for performance that stays fairly steady over the course of the year. Our defense operation has performed solidly, in terms of the transactional portion — that is, the defense piece of our distribution — and definitely the program activity. There was some movement you could observe. During this quarter, we experienced genuinely strong gains from Mobility, which we referenced. I'd describe that as heightened activity in this quarter. We anticipate it going back to more typical amounts in the quarters that follow. Yet on the whole, the government operation has remained reasonably steady during this stretch, and we anticipate that will continue to be true. That said, we do have — as I noted — a strong pipeline of bids plus RFPs that we are answering. So a great deal of activity remains in the government arena. At the moment, everything is progressing quite slowly. COVID — it starts out slow, and we've discussed extensively, clearly, the protest difficulties whenever we pursue these new contracts. Yet COVID has unquestionably decelerated matters within government acquisition; thus that is causing delays. Still, there are wins that might convert and add to this fiscal year; and should we succeed with any of them, we will definitely make an announcement and talk about how it could further enhance the results.

All right, that helps. And Sean, I wonder if you could give us some sense of what gross margins look like in the commercial side versus defense? Given how large Expeditionary is, modeling that is pretty difficult, so could you give us a bit of visibility on gross margins across those 2 segments, commercial and defense? And then, is that 12% gross margin something that holds up at these volumes? And if volumes improve, margins ought to improve too — is that a reasonable way to look at it?

Yeah. On gross margin specifically, yes, you did observe that increase in Expeditionary Services, and most of it was driven by the Mobility business. In Aviation Services, margins declined, falling to 12% from 15% a year earlier. Government was basically flat. So much of that decline stemmed from softness in the commercial top line; that gives you some sense of how margins moved year-over-year across commercial activities and government. And my expectation is that government, aside from that Mobility piece, ought to be mostly steady for the year.

All right. And then, John, would you mind discussing the Frontier award? Perhaps when those talks began. And also maybe a bit more broadly about the kinds of discussions carriers are currently having? Has the focus moved away from simply staying alive toward attempting to map out what the situation might actually resemble after all this?

Yeah. Absolutely. I suppose there are 2 points to make there; where a given customer stands really shapes the answer. For some of the customers we talk with — and these remarks apply globally — the discussion is overwhelmingly about survival. For others, though, we're engaged in, I'd call them, quite forward-looking discussions regarding ways our offerings might assist them. That applies both to customers we already have and to comparatively recent ones such as Frontier. Through the years we've had a relationship with Frontier of differing intensity, yet within this contract it has mostly been transactional; dollar-wise the contract isn't large, but signing something on a multiyear basis with Frontier made us quite glad. And I'd describe this as illustrative of the way carriers will consider solutions, be it USM or maintenance work sent outside that they previously kept in-house, and so on. It shows how carriers will probably wish to be, and need to be, far more inventive regarding cost management across this stretch; plus the Airinmar product covering warranty management and warranty claims, along with our repair cycle management, counts as an inventive product. So it's good to see Frontier put pen to paper on that contract, and we'll pursue more of the same.

Is it fair to say, John, that those talks are somewhat less frequent or less robust than you might expect them to be 6 months from now, once there's a clear line of sight into what airline demand looks like on the other side of this?

Yes. I'd anticipate that the conversations will get more robust over time. And speaking of that, we've seen, just in the last few weeks, multiple projects and multiple initiatives we had with various customers before COVID. A lot of those things got put on hold due to COVID, because it was simply all hands on deck. We've seen some customers show interest in restarting those conversations now that they have better stability. But again, it truly varies by the customer.

First off, I'd like to ask about the MRO business. If the loading comes in the way the airlines are saying it will right now, do you have enough staff? Or might demand end up exceeding what you're able to handle? And where do things stand on the labor front when it comes to backing up the business?

Good question. To satisfy that demand, right now we're bringing back a large number of employees who had been placed on furlough. In fact, at a few of our locations, we're adding people past those recalls — beyond the workers coming back from furlough. When we did the furloughing, sure, but when we released people, we tried as hard as we could to keep in touch with our strongest performers and, plainly, to treat them well while we were shrinking. And up to now, in the markets, we're having decent luck bringing talent in. We've been quite open about this. We're intensely focused on every initiative we had going into COVID, our school partnerships, our training, all we could do to build a talent pipeline of our own. Over the last 6 months, we've tried our hardest to keep those efforts alive, since we want to be sure that when demand comes back, we can reach the industry's finest talent; we know some rivals are out there recruiting too, and we want AAR to be the employer of choice. So the brief answer to what you asked is we're in the market. We're returning people from furlough. We're adding net new workers at certain sites. And so far, it's going okay. Still, we're quite conscious of how full recovery might look and of the reality that some people may have left the workforce for good. So we have to be sure we're bringing new talent in from the schools.

All right, that's useful. And when you consider the conversations taking place right now, could you offer any thoughts regarding labor rates? And regarding how much you might need to adjust those to account for the airlines' financial situation? Or can you hold rates steady and, ideally, begin pushing for some increase on the MRO side?