AAR Corp. (AIR) Earnings Call Transcript & Summary

Thanks, and good afternoon to all of you. I'm grateful you could be with us today as we go over what we achieved in the first quarter of fiscal year 2024; the year has gotten off to a really robust beginning, and I feel both motivated by the momentum we've kept up and proud that our team keeps performing. To put a finer point on it, revenue during the quarter rose 23% compared with the same period a year earlier, climbing from $446 million to $559 million. Our commercial customer sales grew 34%, while government customer sales were higher by 3%. Inside Parts Supply, revenue climbed 40% versus the equivalent quarter last year, reflecting how we're turning the USM investments we made during the past year into revenue and how distribution contracts won recently keep maturing. On the subject of USM, supply is still constrained, yet our sourcing personnel around the world keep locking in material that's in high demand. New parts distribution posted further growth in our commercial product line, which more than makes up for weaker parts revenue from the U.S government. Over in repair and engineering, revenue rose 8% relative to the same quarter a year ago, powered by ongoing strength at our hangars and partly held back by a deceleration in our landing gear business stemming from the timing of the repair cycle for particular gear types; for integrated solution, revenue grew 22% versus the comparable quarter last year thanks to more flight hours under our power-by-the-hour program, the contribution from track, and robust performance in our government programs. It's worth highlighting that our F-16 program in Europe is still ramping up and will contribute more meaningfully as the year moves along. Moving to profitability, our adjusted operating margin came in at 7.3%, an increase from 6.9% in the equivalent quarter last year. Adjusted operating margins widened across every segment we have apart from expeditionary, and this marks our 10th straight quarter of year-over-year adjusted operating margin expansion. Adjusted diluted earnings per share from continuing operations climbed 28%, going from $0.61 per share to a first quarter record of $0.78 per share. On the cash side, as we mentioned on last quarter's call, we identified appealing chances to put money into our Parts Supply segment during the quarter, and that produced a cash use in operating activities from continuing operations of $18.5 million. More precisely, we invested $38 million net in inventory within our Parts Supply segment to back both USM demand and the distribution contracts we won recently. It deserves mention that the parts supply investments we made previously are precisely what generated the growth and profitability seen this quarter, and we anticipate solid results from these newest investments as time goes on too. Even following these growth investments, our net leverage at the close of the quarter stood at just 1.1 to 1.18x adjusted EBITDA, so our balance sheet stays extremely strong. Before I get into new business, I want to address the recent news about a parts supplier that allegedly furnished uncertified parts with forged paperwork for use in CFM engine repairs. AAR < > purchase and were sold any parts from this supplier. For almost 70 years since we started this company, quality and safety have been our driving focus, and when we bring in parts, we apply the most rigorous diligence possible. The value of our quality system has been made clear by this incident, and our expectation is that customers will put even more weight on AAR's reputation for getting things right; let me now move on to new business. We announced two multiyear commercial agreements with Moog during the quarter, one covering distribution and the other covering reciprocal component repair services. These deals matter because they represent the first steps in a fresh strategic relationship with Moog, which we anticipate will open up new opportunities; separately, after the quarter closed, we announced an exclusive multiyear agreement with Pall Corporation, a Danaher Company, to distribute highly engineered filtration products to foreign military customers. Through this agreement, the extended customer reach that AAR offers our partners is recognized, along with the investments we have made in recent years to strengthen our foreign military sales capability and our compliance programs. I'll now hand things over to our CFO, Sean Gillen, who will walk through the results in more detail.

Appreciate that, John. Revenue for the quarter came in at $549.7 million, which represents a 23.2% increase compared with the same period a year ago. Within that, commercial sales rose 33.7%, powered by gains throughout our commercial operations, especially in parts supply. Government sales, meanwhile, grew 2.9%, mainly on the strength of integrated solutions, though that was partly offset by lower new parts distribution results in part supply and expeditionary. On gross profit margin, we posted 18.4% for the quarter — flat versus the year-ago quarter as reported, and an improvement over the 18.1% adjusted figure from that same prior-year period. Our commercial business delivered a gross profit margin of 19.3%, while the government business came in at 16.3%. SG&A for the quarter totaled $74.7 million. That figure includes the $11.2 million charge tied to the Russian court judgment we told you about last week, plus $2.8 million related to Trax acquisition and amortization expenses, along with greater investments in the business. On that Russian judgment: a court ordered us to pay an amount equal to the purported fair value of aircraft engines that we bought from a Russian airline back in 2016 and 2017. We disagree strongly with this Russian court ruling and, as we stated in our September 22 8-K, we view the judgment as stemming from, among other factors, a hostile business and legal climate for foreign companies operating in Russia. Beyond that, we believe our defenses are strong against any effort that might be undertaken to recognize and enforce this unfavorable ruling. If you set aside the Trax-related expenses and $1.1 million in compliance costs, SG&A was $59.6 million, equal to 10.8% of sales. As we shared last month, during the quarter we reached an agreement that effectively moves our pension obligations and assets over to an insurance company. That deal let us completely secure funding for plan participants and do away with our plan management duties and the related funding risk moving forward. Given the plan's funded position, no extra contributions were needed as part of the transfer. In fact, there was a funding surplus of $7.6 million, which we anticipate directing toward certain 401(k) contributions. Tied to this transaction, we recorded a noncash pre-tax pension settlement charge of $27 million during the quarter. We take real pride in having honored the commitments made to plan participants, and we've now wrapped up our work related to the U.S. pension plan. Net interest expense for the quarter was $5.4 million, versus $1 million a year earlier, reflecting higher interest rates and borrowings. On our effective tax rate, we anticipate it will land at roughly 27% for the rest of the year. Cash flow used in operating activities from continuing operations was $18.5 million. As John mentioned, that usage stemmed from a net inventory investment of $37.9 million in our Parts Supply segment, made to support demand for both USM and new parts distribution. More specifically, those investments covered a range of engine platforms for USM material, plus inventory to back certain recently awarded distribution lines. Looking ahead, we anticipate that these investments will keep producing a solid return on invested capital. Even once those investments are made, our net leverage stays modest, at 1.18x adjusted EBITDA. We keep observing strong demand for aftermarket parts, along with appealing chances to invest more in parts supply. Having said that, we anticipate generating cash flow from operating activities that is slightly positive in the second quarter. We appreciate your attention, and at this point I will hand the call back to John.

Alright, thanks Sean. Over the past several years, we've taken pride in our capacity to perform well in an especially dynamic setting, and that setting is definitely still dynamic right now. Although we anticipate that worldwide aviation and our key customers will keep expanding, certain low cost and regional carriers have pointed to demand softening along with fuel prices and inflation that continue to be concerns for the industry. Meanwhile, constraints on new aircraft deliveries and the persistent GTF problems mean the existing fleet will keep flying longer, and on the whole that directly works in AAR's favor. So taking everything into account, we anticipate demand for our parts and services will stay strong. Regarding our parts operations, though USM supply is still tight because of the factors I just referenced, we continue to find appealing chances to invest, and we anticipate that eventually, as new aircraft and engines are finally delivered, USM supply availability will steadily get better. In Repair and Engineering, we expect our hangars will stay mostly full for the foreseeable future. Our Miami hangar expansion is moving ahead, and we keep assessing expansion at other hangars where we can work with local government, take advantage of existing overhead, grow our customer commitments and easily obtain labor. On the government front, as you're aware, a shutdown is possible. Should one happen, what we currently expect is that it wouldn't meaningfully affect our integrated solutions business, since we perform work under contracts awarded previously; it could have some effect on our government distribution operations when it comes to payment timing, orders and shipments. Regardless, things are changing quickly, and we intend to stay flexible so we can act as necessary to reduce any effects. Having said all that, broadly speaking, we view a tight budgetary situation as favorable for our efficient commercial best practices offerings to our government customers. Turning to Q2 as a whole, presuming there's no prolonged government shutdown, we anticipate sales and earnings growth both year-over-year and sequentially. To be specific, we expect mid to high teens sales growth year-over-year, with operating margins comparable to or above what we achieved in Q2 of last year. More broadly, the demand signals coming from our main customers give us encouragement. And that, together with the industry's ongoing dependence on current generation aircraft, produces a highly favorable operating environment. At our government business, as we secure new contracts and attention turns to fleet readiness, we expect to speed up our growth trajectory. Once more, our very strong start to the year is encouraging, and we look forward to continuing to put money into our business and our people to generate additional growth. With that, I'll hand things over to the operator for questions.

Hey, good afternoon.

Hey, Rob. How are you?

Great, thank you. I'd like to hear your thoughts regarding the strong sales increase you had this quarter, plus what you mentioned a moment ago about the upcoming quarter, and how that squares with the 5% to 10% CAGR you're aiming at across the coming years. And John, perhaps as one piece of that, does the GTF matter, and what does it mean on your end?

Absolutely. Appreciate it, Rob. Those are all solid questions, same as always. Regarding the quarter, it's clear we're extremely pleased with the results we posted. Growth was quite robust throughout the entire company, especially within the parts business, and in terms of the 5% to 7% guidance we issued, that clearly is a target spanning multiple years; and as we keep ramping up, the year-over-year comparisons are going to keep rising; so our focus is on the years to come; but near term, as we said about Q2 and the remainder of this year, we specifically anticipate coming in above that long range target.

Okay.

And on the GTF …

All right. All right. Is there — yeah, that’s exactly what I was …

Yeah, and regarding the GTF, I’d put it this way: anything at this moment that pulls next gen aircraft out of service and shifts greater focus toward the current generation of aircraft works in our favor. So if you’ve got 600 or more aircrafts that are going to be coming out for these mods < > over the next couple of years, that’s simply going to place additional strain on the existing fleet, which is our bread and butter right now. So net-net that that will likely be a positive for us. The flipside is, it’s going to continue to constrain the supply for USM material. But as we’ve demonstrated last year, and this year with some of the investments we’ve been able to find and make, we’re still — we believe doing a good job of growing out there and finding material to support this great growth even when the supply is tight.

All right, that's really useful. I'd like to follow up about distribution. Looking at it, you keep signing new agreements, and you've made it plain those need a couple of years before they fully ramp, so over time we ought to see a bigger sales contribution from the most recent ones. But what's the proper framework for margins in this segment? Before Boeing bought KLX, it sat in the mid teens. At the same time, some other distributors have run somewhat lower — AVR comes to mind. How should we properly frame the margin profile here?

Right, we'd likely land somewhere in between. The margins for that business, if they're above the company's overall margin at present. So as that business keeps expanding, the mix shift works in our favor; that explains part of why you've watched operating margin steadily improve across the last 10 consecutive quarters. And as we've discussed, we — thanks to our market position as the biggest independent, plus our balance sheet — can keep moving forward and put money into these programs, while our bigger rivals, my Airbus and Boeing, lack that independence or the focus on this kind of investment; so we view it as a terrific chance for us to keep grabbing share. And as that mix shift keeps tilting toward parts broadly, yet most particularly distribution, it will be accretive to operating margins.

Alright, that's great. Just a fast question, and this one is directed at you, Sean. The margins for this quarter came in somewhat weaker compared to the one before, and my understanding is you had expected them to be roughly flat. What's driving that?

Yeah, so if you look at the breakdown of the segments — that's included in the release and also in the Q that will be filed — I'd say margin was still a very solid result, with a meaningful gain versus the same period a year ago. But like you said, on a sequential basis there was a modest step down, and much of that occurred in parts, which was fairly in line with the comparable quarter last year — slightly lower — and that really just reflects the mix from an exceptionally strong Q4 that closed out the previous fiscal year, combined with what we saw this quarter.

All right, I appreciate that. Thanks for the additional detail.

All right. Thank you, Rob.

Hello there, good evening, everyone. Strong results. Appreciate you taking my question.

Thanks.

John, perhaps returning to what Rob asked — when we look at the guidance for the second quarter, I believe you mentioned a year-over-year figure in the mid to high teens. Nothing was said about the sequential picture, as far as I can tell. First quarters are typically softer from a seasonal standpoint, I realize, yet that would suggest things may be roughly flat quarter to quarter, or only marginally higher. What I'm asking is whether you could share additional detail on how we ought to frame 2Q and the seasonal patterns, specifically whether they showed up this quarter the way they usually do.

Certainly. That's a terrific question. We < > anticipate a modest sequential increase; and regarding seasonality, what we've observed now, in this period coming out of COVID, is that — if you remember, before COVID, a fairly significant decline from Q4 into Q1 was something we would certainly experience. That clearly did not occur this quarter, and we take a lot of pride in that; and last year it was milder than in earlier years. The explanation is that we truly collaborated with the customers in our hangars to align < > with the operation. We've likewise kept honing which customers we serve in those hangars; however, the airlines, even if they'd like their planes flying as much as possible through the summer, understand that sustaining the work, keeping the workforce intact, in light of the labor supply constraints, benefits everyone. Therefore we do anticipate ongoing mild seasonality ahead, though not at the level we would have experienced previously, because of the shifts I just described.