AAR Corp. (AIR) Earnings Call Transcript & Summary

Hello, everybody, and thanks for joining us on this call covering AAR's first quarter of fiscal 2023. Here with us are John Holmes, our President and Chief Executive Officer, along with Sean Gillen, our Chief Financial Officer. Prior to getting started, I want to note that remarks we make today could contain forward-looking statements, consistent with how that term is defined under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements carry risks and uncertainties, which might lead actual outcomes to differ materially from what those statements suggest. As a result, they should not be viewed as a promise of future results; those risks and uncertainties get covered in the earnings release issued by the company as well as the Risk Factors portions of the company's Form 10-K covering the fiscal year that closed on May 31st, 2022. When offering forward-looking statements, the company takes on no duty to issue updates reflecting later circumstances, or events that are anticipated or unanticipated. We will also touch on certain non-GAAP financial information during today's call. A reconciliation linking those non-GAAP measures to the closest comparable GAAP measures appears in the company's earnings release. Right now, I'd like to hand the call over to AAR's President and CEO, John Holmes.

Okay, thanks, and good afternoon to all of you. I'm grateful you could be with us today as we go over the results for our first quarter of fiscal year 2023. Revenue during the quarter declined 2%, moving from $455 million in the same quarter a year ago to $446 million. Adjusted diluted earnings per share from continuing operations rose 17%, going from $0.52 per share to $0.61 per share. Sales to our commercial customers were up 10%, while sales to government and defense customers fell 19%; within our commercial business, we're still encouraged by the ongoing rebound in air travel. As we mentioned last quarter, that rebound has been most pronounced domestically, whereas Europe and Asia have trailed, which leaves global ASMs roughly 30% under 2019 levels. That matters most for our parts activities, which are the most international of our operations. When it comes to those parts activities, we're still seeing widening interest in used material, though near-term demand for used parts remains affected by green time utilization and by a shortage of material availability for certain high-demand assets; that said, our new parts distribution activities keep producing substantial growth. Although contracts signed before COVID have yet to fully recover, the broader growth is coming from the series of distributorships we've signed over the last two years. We keep gaining share in the new parts distribution market and anticipate that growth will continue. Lastly, in MRO, our customers keep signaling robust demand for our services, and we anticipate our hangars will stay mostly full through the remainder of the fiscal year. In our government business, on a year-over-year basis, we felt the full effect of the Afghanistan exit along with the completion of certain other programs. On a sequential basis, the decline came from lower activity on certain short-term programs, plus a more typical level of parts sales to the U.S. government compared with what we saw in Q4. As our recently awarded U.S. Navy contract ramps up later this year, and as we win additional contracts, we anticipate growth will return in our government business. Turning to margins, I'm happy to say we posted another strong quarter. Our operating margin came in at 6.9% on an adjusted basis, compared with 5.5% last year. We keep showing that the structural changes we made during the pandemic have produced a lasting margin improvement. On cash flow, we generated $7 million from operating activities from continuing operations; this quarter we saw opportunities to acquire high-demand assets that we expect will drive growth in our parts activities; that illustrates our ability to use our strong balance sheet to act quickly and seize market opportunities. We also bought back $22 million of stock during the quarter under our share repurchase program. Even following the share repurchase, our net leverage stood at 0.4 times EBITDA, and we remain exceptionally well positioned to fund our future growth. Now regarding fresh awards, in the quarter our mobility systems unit secured a firm fixed contract worth $173.5 million from the U.S. Air Force for manufacturing next-generation cargo pallets made entirely of aluminum. At present we build and service the 463L cargo pallets of the current generation, and this new award extends our backing of the U.S. Air Force well into the future. Also, the Norwegian Defence Logistics Organisation granted us a contract to supply parts for the Royal Norwegian Air Force P-8A fleet. That initiative extends our successful strategic growth into government programs beyond the US. Lastly, we revealed that Textron Aviation Defense has implemented our Airvolution digital repair cycle management tool. Airvolution is a customizable SaaS solution designed to optimize how aircraft component repairs are administered, and Textron Aviation Defense will depend on Airvolution to enhance and update its workflows for repair orders; having said that, I'll hand things over to our CFO, Sean Gillen, who will walk through the details of the results.

Appreciate that, John. Revenue for the quarter came in at $446.3 million, which represents a decline of 1.9%, or $8.8 million, compared to the same period a year ago. On the commercial side, we saw growth of 9.8%, whereas government sales fell 18.7%, driven by the wrap-up of several government programs, among them our Afghanistan contracts. Looking at it sequentially, commercial sales stayed roughly level, and government sales dropped 16.2%. For the quarter, gross profit margin stood at 18.4%, up against 14.2% in the comparable quarter last year, while adjusted gross profit margin reached 18.1% versus 16.1% in that same prior-year quarter. Within our commercial segment, gross profit margin was 18.2%, and within government it was 18.6%. On the government side, the robust margin result came from recent contract modifications allowing for greater recovery of indirect costs, plus strong cost performance on a contract. SG&A costs for the quarter totaled $50.1 million, a figure that reflects ongoing spending on our digital initiatives and also includes $0.8 million tied to investigation and remediation matters. Net interest expense came to $1 million this quarter, versus $0.7 million a year earlier, as higher interest rates more than offset reduced borrowings. As John mentioned, cash flow from operating activities from continuing operations was $7 million. We also put $21.9 million toward share repurchases. Our balance sheet stays extremely solid, with net debt at $70.7 million and net leverage of just 0.4x. Just as in the past three quarters, we intend to keep carrying out our plan to deploy the entire $150 million share repurchase authorization across roughly 2 years from when it was announced. And lastly, we expect to invest more heavily in inventory and renewable assets to fuel our growth. Thanks for listening, and I'll hand the call back to John now.

Alright, thanks, Sean. As you're aware, we're currently navigating a stretch of macroeconomic unpredictability when it comes to expansion and pricing pressures. Even so, growth in commercial passenger traffic has, over the course of economic cycles, tended to be remarkably sturdy. When it comes to AAR, as I mentioned previously, we anticipate our hangars will stay mostly filled, and while the labor market is still constrained, our collaborations with technical schools, along with other efforts to build a labor pipeline, keep paying off for us. On the distribution side, we're in a strong spot to keep bringing on new lines and to gain from the eventual rebound in flying activity across Europe and Asia. Within trading, green time on engines will in time fade away, and deliveries of new aircraft will sooner or later create retirements that supply more used material. All of this ought to produce a turning point in how our trading volumes recover. Just as we witnessed throughout the pandemic, our government segment has likewise demonstrated resilience when the broader economy weakens. On top of that, our core value proposition — providing commercial best practices at a reduced price — ought to land with even greater force among our government clients when budgets get tighter. Consequently, we feel assured about our capacity to convert our government pipeline, which is still quite full, into significant growth down the road. Regarding what's ahead in the near term, we anticipate growth in Q2 on both a sequential and a year-over-year basis. To be specific, we expect sales to land somewhere between the quarter we just closed and Q4 of last year, and we stay hopeful about ongoing sequential growth across the rest of this fiscal year. Looking further out, we hold a distinctive position as the top non-OEM, non-airline supplier of complete aftermarket solutions worldwide. We're nicely diversified between commercial and government end markets, we possess the robust balance sheet needed to drive market share gains, and we have a margin profile that's structurally better, which ought to deliver still more value to our shareholders. With that said, I'll hand things over to the operator for questions.

Hi there, good afternoon everyone, and thanks for fitting in my question. John, you just offered some insight into what the year might look like in terms of growth coming in sequentially. And Sean, I believe you mentioned putting money into inventory in order to get ahead of that growth. So, do you still anticipate some kind of inflection point arriving during the back half of this fiscal year? And then, could you perhaps share a bit more detail about margin? The performance this quarter was certainly strong. As growth picks up further, should we count on margins staying steady, or will there be some mix-related problems we ought to know about?

Yes, thank you, Mike, and I appreciate you joining. Broadly, when I look at the parts businesses across two areas, distribution, we anticipate growth across the entire year. We have executed quite a few agreements, and those contracts are now reaching maturity. What you're observing is ongoing improvement on deals that existed prior to COVID, and we anticipate distribution growth for the whole year. Regarding the aftermarket, the trading side, I'd characterize that as an inflection point, and a couple of conditions need to happen. We're witnessing, you know, sustained utilization of green time among our customers. Some engine overhauls are getting pushed back that we would have expected by this point because planes are sitting on the ground. Aircraft are grounded owing to pilot shortages and other factors. That is delaying that inflection point, yet we still anticipate it happening, you know, during the back half of the year. When it comes to margin, you've observed the complete advantage of the structural modifications we've implemented, and that has placed us near the 7% operating adjusted operating margin range. As the parts businesses rebound in both distribution and trading, and that represents the segment where we continue to see the greatest potential for recovery and growth, those businesses are margin accretive relative to where we stand now. As the mix moves in that direction, that should eventually enhance margins even more.

Understood. Regarding putting money into stock to fuel expansion and also considering distribution, what are you observing when it comes to the supply chain? Are there any difficulties around, say, repairs or obtaining components from the main OEM vendors? Or does that sit somewhat lower on your list of concerns, perhaps trailing labor?

Yeah. That's a fair question. I'd say staffing is absolutely where our focus sits first. Without a doubt, within the distribution operation, the difficulties around supply chain are a key area of attention for us. Our people have handled that quite well. It has affected what we've delivered to some degree across the recent quarters — things like shipments arriving late and repairs taking longer. On the whole, I believe we've navigated it reasonably effectively.

All right, this is my final question. Is there any news? I realize you mentioned the ADL drag kits during the previous quarter. Is there anything new on that front, or what sort of outlook should we have regarding that program?

I'd say no meaningful update.

Okay.

Things are still moving along nicely with that initiative, and as you're aware, ADL is in discussions with quite a few prospective buyers.

Okay. Fair enough. I'll jump back in the queue, guys. Thanks.

Thanks, Mike.

Yeah, good evening.

Hey, Josh.

Yeah. You said you anticipate hangar demand, or the hangars themselves, will stay pretty much full. Could you shed some light on that? Has the mix of aircraft shifted at all? Is it still exclusively narrow body? Are any reservation trends evolving, or does demand look basically unchanged?

For the most part, I'd call it unchanged. The bulk of what we do centers on narrow body maintenance. That said — and we highlighted this earlier in the year — we've managed to reshape our customer relationships in a way that significantly reduces the seasonality this business used to experience. There was some, meaning certain maintenance lines disappeared over the summer since planes were in service. Those will return come the fall; the impact was far smaller than in prior years. We're quite happy that our customers are collaborating with us on this, since our goal is steady aircraft and steady workloads all year long, which lets us retain our workforce while also generating the efficiency and better margins that you've observed.

Yeah. About distribution, who are you gaining share from? Bigger companies or smaller mom-and-pop operations? Is there consolidation happening in the industry that you believe will keep trending for a while?

Yeah. A lot of the wins we've announced over the past couple of years have come from the larger players; that would be Aviall owned by Boeing, Satair owned by Airbus, and then a handful of smaller but predominantly the larger players.

Understood. Let me ask just one more thing regarding the Southwest relationship. Has anything shifted on that front? Are there any dynamics you're able to discuss or point out to us?

The relationship with Southwest? Regarding that aircraft parking situation. No. There's nothing fresh to report. They continue to be one of our biggest customers and a fantastic partner.