AAR Corp. (AIR) Earnings Call Transcript & Summary

Good afternoon, everyone, and thank you very much. We appreciate your joining us today as we review our Q1 FY 2022 results. Even with COVID-19 continuing to affect us, our positive momentum carried forward, and we turned in another quarter of strong performance. Revenue increased 14% year over year, going from $401 million to $455 million. Adjusted diluted EPS from continuing operations rose 206%, from $0.17 per share to $0.52 per share. Commercial customer sales grew 52%. Government and defense customer sales declined 17%. One thing that stands out to us is that we grew 4% going from Q4 into Q1, despite the fact that our business normally sees the first quarter come in lower than the fourth due to seasonality. In our commercial operations, sequential growth hit 17%, and it was our parts businesses that powered that gain — a promising sign that demand is coming back. Strong appetite for our airframe MRO services also contributed to how well the quarter went. It's worth noting that the bulk of our MRO volume was standard maintenance rather than catch-up work. On an adjusted basis, operating margin for the quarter landed at 5.5%, compared with 2.5% a year ago and 5.2% in Q4. To put this in perspective, our margin for this quarter came in above where it stood two years back, before the pandemic hit, despite a revenue decline of $86 million, or 16%. What that tells us is the operating leverage we've built up over the past 18 months — streamlining our MRO operations, getting out of underperforming activities, and cutting indirect and overhead costs — is paying off. On the cash side, we had another solid quarter, bringing in $18 million from operating activities from continuing operations. We also kept lowering how much we draw on our accounts receivable financing program. If you set aside the effect of that AR program, cash flow from operating activities from continuing operations came to $26 million. After the quarter closed, we shared news of several new business wins. To start, we revealed a sole-source arrangement with Arkwin, which is part of TransDigm, covering the distribution of engine actuation alongside other commercial aviation goods. This win shows how effective our standalone distribution model is for component OEMs, and it also highlights the robustness of our balance sheet. Next, we disclosed a deal with the Department of Energy involving the modification and handover of a 737 to 700 aircraft, configured so the DOE can switch rapidly between carrying passengers and carrying cargo. Much like the earlier C-40 aircraft delivery agreement we had with the United States Marine Corps, this deal illustrates how much government buyers can save by purchasing through the aftermarket. We shared news that we're broadening our component support agreement with Volotea, a Spanish low-cost airline that's expanding, and this speaks to how the market keeps wanting this kind of offering plus our capacity to bring down operating costs while delivering strong operating performance. Before I hand things off to Sean, I want to say something about how essential AAR's role was in the U.S. When it came to the withdrawal from Afghanistan, we had over 150 people stationed there, and the majority of them were supporting our WAAS program. Over a 36-hour period, about 2,000 U.S. Embassy staff were transported by our WAAS team to Kabul International Airport as part of the evacuation operation. Every one of our employees also made it out of the country safely afterward, and I take enormous pride in how our team backed State Department personnel through extremely challenging conditions. Having said that, I'll hand things over to Sean Gillen, our CFO, so he can walk through the quarter in greater detail.

Thanks, John. Sales for the quarter totaled $455.1 million. That's up 14%, or $54.3 million, from the prior-year period. In aviation services, revenue increased 19.8%, driven by a rebound in our commercial markets. For expeditionary services, sales dropped by $17.7 million, a result of the Composites divestiture and a strong prior-year quarter for the U.S. Air Force pallet contract. For the quarter, our gross profit margin was 14.2%. A year earlier, that figure was 12.1%. Adjusted gross profit margin reached 15.1%, versus 13% in the same quarter last year. This meaningful gain comes from the cost takeout and efficiency programs we've implemented. As the commercial market comes back, we'd expect to keep generating stronger gross margins, since a portion of our cost of sales is fixed, and since our parts business carries higher margins and hasn't yet participated in the market recovery to the same extent as our maintenance business. During the prior quarter's call, we mentioned that a contract within one of our commercial programs had been ended. Charges of $10 million were recorded, largely tied to that cancellation along with an impairment of an asset. For the quarter, SG&A came in at $49.3 million, representing 10.8% of sales. If you set aside roughly $1 million in severance, the figure would be nearer to 10.6% of sales. That compares with 11.3% a year earlier and 11.2% in Q4, so it's lower. Keep in mind that the prior year's numbers included certain short-term cost savings from reductions to salaries and benefits that lasted until Q2 of last year. Net interest expense totaled $0.7 million this quarter, versus $1.6 million in the same period last year, due to reduced borrowings. For the quarter, diluted shares averaged 35.7 million, compared with 35 million a year earlier. Turning to Afghanistan: on last quarter's call, we noted in-country work on two programs — WAAS, which supports the State Department, and C-130, which supports four Afghan Air Force aircraft. As the State Department withdraws from Afghanistan, we're winding down the associated work and anticipate finishing later in this quarter. Right now the C-130 effort continues, supporting two of those four aircraft, which are based in the UAE. All told, FY '21 sales in Afghanistan came to $67 million. These activities produced margins in line with what we've previously characterized for the entire WAAS program — an operating margin in the high single digits. As John mentioned, cash flow from continuing operations' operating activities came to $17.5 million, reflecting our ongoing efforts to bring down rotables and inventory balances. We also trimmed our accounts receivable financing program by $8.4 million during the quarter. With net debt at $80.2 million and net leverage at just 0.6 times, our balance sheet stays exceptionally strong. Thanks for listening — I'll hand the call back to John now.

Alright, thanks, Sean. As we look ahead, we anticipate that demand for our MRO operations is going to stay robust, since airlines keep concentrating on two things: being ready to enable the rebound in air travel, and maintaining a sound maintenance supply chain. When it comes to parts supply, although activity levels rose during the quarter, we anticipate steady results in the near term given the uncertainty the Delta variant has generated. On the government front, leaving Afghanistan, along with programs that are approaching their natural endpoints, will create a near-term effect on our business. That said, our Department of Energy contract is an award that offsets this and showcases the core value proposition behind our commercial best practices business model; beyond that, we keep accumulating a strong track record of past performance. Consequently, we think that as time goes on, we stay in a terrific spot to expand our government business by winning additional programs and enlarging our existing positions. Given these near-term dynamics, we presently anticipate that overall Q2 performance will look much like Q1. Although uncertainty persists regarding when the recovery will happen, we are certain that it will happen, and we think our positioning is outstanding; we have come out of the crisis with a balance sheet that is even stronger. Our government and commercial pipelines are full, and the operating leverage we have established puts us in a position to keep pushing additional margin expansion; with that, I'll hand it over to the operator for questions.

Hello there, good evening, everyone. I appreciate you answering our questions. Strong results too, I might add. Perhaps regarding those final remarks you offered, with 2Q appearing comparable to 1Q — does that refer to both the top and bottom lines, or were you mainly pointing to the revenue figure?

As things stand right now, our view covers both up and down, though I want to stress once more that the climate we're operating in remains unpredictable. By comparable, what we're indicating is the top and the bottom.

All right. Just attempting to get a feel here, and perhaps I'll weave this in, but the implied sequential commercial growth in aviation services you had looked really strong. Did some of that come from your extra customers, possibly international ones, and maybe I'm specifically thinking about Air Canada coming online, and does that keep growing as these other markets open up? Are we just looking at the top line headwind, all stemming from the WAAS contract?

Yeah.

What exactly drove it?

Sure. Demand was the main factor. Our commercial segment performed very well in every area. Trading led most of that growth, and although it remains well below where things stood before the pandemic, it showed solid improvement from one period to the next. Activity kept rising as the quarter went on, yet in recent weeks the recovery's pace has become steadier and more moderate. We tie that to the drop in orders from our commercial clients that you've observed. Your point about Canada is accurate. We're pleased that Canada has reopened and that customers there, especially Air Canada, are generating more business. It didn't add much to this quarter, though we anticipate it will boost future results.

All right, understood. Regarding the gross margin specifically — I realize that on an adjusted basis you clearly posted solid growth compared to the same period last year. But looking quarter over quarter, it came down somewhat, and you mentioned parts were actually picking up slightly or bouncing back a bit. What other factors contributed to that sequential gross margin decline, especially with such a robust top line? Was it simply a larger share of MRO, broader mix considerations, or is there anything further you could share?

Yes. Hi there, this is Sean; things were somewhat uneven on the government side. That area slipped slightly on a sequential basis. During our Q4 call, we mentioned that certain events in Q4 generated unusually high profitability from some government work. You observed a modest reduction in that, and that is precisely what caused the sequential drop from 16.5% down to 16.1%, yet we continue to feel quite confident about profitability overall. As we have discussed, with parts continuing to expand, that will contribute favorably to the margin.

Understood. Regarding the parts, I'll give it a try. I don't know whether you folks will offer much detail, any perspective or anything you might share about where things stand with Fortress and what we should anticipate?

Sure. Things are going extremely well. That program is delivering precisely as we anticipated. Fortress is an excellent partner and is fulfilling everything they committed to. At this stage, that program is a complete contributor. I'd describe it as essentially at full run rate during the quarter, and we anticipate those levels will remain steady for the remainder of the year.

Understood. That's useful. Okay, I'll get back in line. Thanks, everyone.