Q2 2021 AAR Corp Earnings Call
Good afternoon, ladies and gentlemen, and welcome to A. ours. The school 2021 second quarter earnings call we.
We are joined today by John Holmes, President, Chief Executive Officer, and Sean Gillen, Chief Financial Officer.
Before we begin I would like to remind you. The comments made during the call may include forward looking statements as defined in the private Securities Litigation Reform Act of 1995.
As noted in the Companys news release, and the risk factor section of the company's form 10-K for the fiscal year ended may 31st 2020, and form 10-Q for the fiscal quarter ended August 31st 2020.
In providing the forward looking statements. The company assumes no obligation to provide updates to reflect future circumstances or anticipated or unanticipated events. At this time I would now like to turn the call over to a ours president and CEO John Holmes.
Great. Thank you very much and good afternoon, everyone. I. Appreciate you all joining us today to discuss our second quarter fiscal 2021 result.
Before we discuss the result of though I would like to thank all of our employees for the continued resiliency encouraged they have shown over the last three quarters of we've navigated the and on <unk> in particular, one of the two thirds of our people are essential workers. They of continuing to come to work every day, enabling us the continued to deliver for our customers.
I'm very proud of our entire team.
I also want to thank Congress once again birth work on the cares Act, which has a lot of companies like ours to preserve the skilled workforce.
Regarding the business as we indicated last quarter overall, we have seen our commercial volume stabilize and continued strong performance out of our government business.
While we remain in a difficult and uncertain environment. We are encouraged by the stabilization as well of the positive developments regarding the back of themes, which not only will protect our people, but should also ultimately lead to more travel and the recovery in our commercial markets.
With that turning to the quarter, our sales decreased 28% year over year from $561 million, the $404 million and our adjusted diluted earnings per share from continuing operations decreased 52% from 64 cents per share the 31 cents per share.
Our sales to commercial customers decreased 48% on our sales the government and defense customers increased 13% for.
For the quarter sales the government defense customers were 52% of our total sales.
Our aviation services segment grew 6% sequentially from our first quarter. This was the result of increased volume on <unk>, the winner and MRO business, which the seasonally higher in Q1 of <unk> Q2 over Q1 as well as the continued strength of our government business on.
Commercial parts volumes overall were relatively stable throughout the quarter and remained above the lows. We saw in April of night.
That said I'm, particularly encouraged by our margin improvement progress over the last several quarters, we have reduced our footprint across the enterprise decreased our indirect and overhead spending.
Exited or restructured several underperforming contracts and divested a lot of making non core business.
You are now starting to see the results of these actions on our adjusted operating margin, which improved meaningfully from two and a half per cent the 4% sequentially on stable revenue.
With respect the cash we generated $28 million from operating activities from continuing operations. It also reduced our accounts receivable financing program by nearly $7 million further improving our already strong balance sheet position and putting on net leverage below one times EBITDA.
We also continue to add significant new business that positions us for growth going forward on.
CFM 56 partnership with fortress solidified the source of supply to meet growing demand for use service of the material on the dash five be on the dash seven be engine variants. We expect the man for you asked them to increase across the board as we emerged from the pandemic and to be particularly strong for these engine platforms.
Also our follow on contract from the Navy to support the T 40 aircraft recognizes our performance over the last five years and provide for an expanded statement of work over the next five years.
It's worth noting that this was the first time that this contract was awarded to an income and which speaks to the high quality of our service.
Additionally, our 10 year agreement with Honeywell to be at the sole authorized service center for 737, Mac electronic bleed air system components positions us to support Max operators worldwide, because that aircraft of returns of the service.
These new contracts along with others, we have announced over the last several months the units than expansion and extension represent nearly $1.7 billion in total contract value captured so far this fiscal year the.
This demonstrates the unique value of our aviation services offering and these business wins will help accelerate on recovery coming out of the downturn.
With that I'll turn it over the rest CFO, Sean Gillen to review the quarter's results in more detail. Thanks.
Thanks, John for sales in the quarter of 403.6 million were down 28% per 157.3 million year over year, driven by the impact of the pandemic on commercial passenger flying activity.
Sequentially Aviation services sales were up 5.9% or 21.4 million while sales in Expeditionary services were down 50 per cent for 18.6 million.
The sequential decline in Expeditionary services was driven by two factors first of the exit of the composites business was completed at the end of Q1 and this business generated 7 million of revenue in Q1 and zero in the current quarter second.
The second as previously discussed mobility had a particularly strong Q1 due to elevated shipments of palace.
Within aviation services, our government and defense business was up 19% were 30 million year over year, reflecting strong performance on existing contracts.
In the quarter as well as in Q1, our program to deliver to see 40 aircraft to the U.S. Marine Corps generated strong revenue due to elevated activity on the program.
Gross profit margin in the quarter increased to 17.2% from 15.3% in the prior year quarter, driven by the cares Act payroll support.
On a sequential basis gross profit margin was up 12 was up from 12.1% in our first quarter, reflecting the actions we have taken to reduce our indirect costs at the exit underperforming contracts and on product lines.
That's your net expenses were 43.4 million for the quarter on an adjusted basis cash DNA was 38 million or 9.4% of sales down 13 million from the prior year quarter, reflecting the reduction of our overhead cost structure.
Of this improvement approximately 3.2 million was the result of temporary reductions in compensation of benefits, which we restored the beginning on December onest.
As an update on our previous disclosure we have been in settlement discussions with the department of Justice regarding on investigation of Air left under the false claims Act.
During the quarter, we recorded 6 million of additional accrual and discontinued operations, which brings our total reserve for this matter to 8 million based on our latest settlement offer.
We generated 27.6 million of cash in our operating activities from continuing operations for the quarter. This is net of the use of cash of $6.8 million as we continue to reduce the size of our accounts receivable financing program.
Excluding the accounts receivable financing program cash flow provided by operating activities from continuing operations was 34.4 million inventory decreased to $12.7 million during the quarter.
Our net debt at quarter end was 112.1 million down $37 million from $149.3 million at the end of Q1 on.
Balance sheet and liquidity remained strong with net leverage of 0.95 times adjusted EBITDA unrestricted cash of 110 million and unused capacity under our revolver of approximately $390 million.
As such we are well positioned to fund what we expect to be unique opportunities to grow our business over the coming quarters. Thank you for your attention and I will now turn the call back over to John Greg.
Great. Thank you Sean overall.
Overall, we are pretty pleased with our results given the current environment and also we use of the progress we have made in improving our operating efficiency as I mentioned for many reasons. We are encouraged by the multiple vaccines coming to market and the plans for distribution as.
The the vaccines are distributed and case numbers decline, we expect travel restrictions to be lifted and people to start flying again.
Until then we expect to be in a relatively stable revenue environment, and we will continue to focus on driving cash flow as well as continued margin improvement.
We will also remain focused on capturing new business and I'm confident that our strong balance sheet combined with the airlines increasing desire for our lower cost value added services will lead the even more growth opportunities.
With that I'll turn it over to the operator for questions.
Thank you as.
As a reminder to ask the question you'll need to press star one on your telephone to withdraw your question press. The pound key please stand by was the compiled the kuni roster.
Again that is star one if youd like to ask the question and our first question comes from Robert.
Gone from Credit Suisse. Your line is now open.
Hey, good afternoon.
Sure.
Good Thanks, and nice margin improvement there John I want to talk about just well I've got a couple of things on a go over but.
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How did how did the quarter look month by month since it looks like you've you've already seen trough at least by a little bit here. This was a little bit up from last quarter. So I assume we're done with that and we're heading north on the revenues, but how did how did that look quarter to quarter by month to month.
Yeah. It was actually it was fairly stable throughout the quarter I would agree that we've seen the troughing of the of the parts volume of the Emerald volumes at all come up from what we saw in the April may timeframe.
But you know heading into the June July period, the volumes that we saw across.
The business of a relatively stable in the month falling.
Okay, and then to what extent can we glean anything from your whatever conversations you're having with customers as they think about the return of Max to serve as the maybe.
Maybe modest increase in production rate of the Max.
You know Airbus has talked about.
Perhaps lifting the production rate on the Athree hundred 20.
As in the obviously traffic we all think is going to come back here have they talk to a little bit about how they expect the fleet to move in response to all of that and how if at all does that affect your MRO schedule and your anticipation of more USM, becoming available if new lift starts to roll.
Place old lift.
Yeah. It you know it really it depends on the customers you know certainly you've seen some of the larger carriers that have a max of on order you know the gone ahead and started taking delivery of those Max's customers that had Max already on the way they've begun operating those you know.
So the those customers appear to be committed the that a the path you know broader though as you know you've seen you have seen the number of cancellations of of the back then.
On the corresponding theme is that we have seen.
Customer the at the same time, they are going to introduce new aircraft. They've also indicated to us that they do expect the hold on to some older per aircraft longer than they would have anticipated over throughout coated.
All of them no I should say have expressed an agenda for the customers that are current.
Current U.S. on customers as lot of customers in regions like a like China.
That are not USM customers, we have seen an interest the across the board in you at the material and during the quarter. We did start to see more aircraft become available for.
For acquisition and ultimately for tear down so.
You know that chain of events, where if the an aircraft to put on the ground. Then ultimately retired then ultimately sold potentially to us on the like asking my tear it down you've seen a bit more of that come into the market and therefore, we expect the supply the start increasing now.
Now are those aircraft that you're starting to see are those Ceos and ngs or are we talking about older airplanes the that really.
Overhauling those wouldn't make any sense you know the the models that are going really out the pasture.
Yeah.
No weve and I don't want to get too much into detail for competitive reasons, but yeah, we've seen a pretty wide range of of opportunity the.
Next day.
Okay, and then just quickly a couple a couple of other things just if we end up a couple of years down the road with the simplify fleet of let's call. It Athree hundred Twentys Ceos in the us to Twentys 300, Fiftys and then on the following side Maxon LNG Triple 7787, and everything else is gone.
Is that.
Better for third party maintenance or worse.
I think overall, it's a I mean I would view it of the positive I mean, we we.
Companies like ours exists to provide a necessary service I mean that that maintenance that maintenance capability has largely been outsourced by most of the carriers and let's use the a compelling event for them to start insourcing that that activity we believe the.
Net you know the.
The the volume of work will continue to exist for third party maintenance providers of nothing in particular.
Okay, and then just last one on margins you mentioned that you see continued margin improvement I think if we go back to your prior element of your your previous higher margins. You were doing added period of time, you had higher SDMA and you also had some contract labor, which we assume is more expensive. So if we look forward and you don't have those two things how do we think about what.
The margins can do is there an incremental margin that you are Sean suggest we'd be using as we look at revenues rise here.
We we would expect that are that we will come out of the this crisis at higher operating margins than we were pre pre coated.
Okay, and the yeah, and and that's due to a number of factors largely to the actions that were taken but your point on contractor at labor is is right on you know we've done a number of things to reset activities inside of our hangers and we do not expect to be as rely on on contract labor going forward as we had been in the past.
That's certainly a contributor we have a number of other efficiency initiatives under the we're in the process of implementing inside of the hangers sort of will be a lot more efficient as that volume of work comes back. But then additionally, there were a number of less profitable activities or unprofitable activities that exist.
The the company pre co the and over the last three quarters, we've done a lot of work.
To eliminate that drag from our earnings and as we recover the stronger performance out of our parts businesses. For example, as well of increased efficiency on the higher the start to see that come through and better margins.
Okay excellent. Thank you.
Thanks, Rob.
Thank you.
And our next question comes from Joseph Denardi from Stifel. Your line is now open.
Hi, Thanks, the good afternoon.
John can you just talk little bit about maybe that the conversations that use the having with some of your airline customers in terms of how they're thinking about capacity of recovery.
Specifically, how those conversations may have changed.
On the last few weeks after the the vaccine.
News of kind of how they're thinking about summer 21 schedules and capacity.
Sure.
You know again, you're in a situation, where a where the conversation of varies by customer, but the the the general themes are a there is a focus on summer 2021 readiness and what was different about the quarter. We went through the versus our first quarter you know during.
During the summer if you recall, we we went through another surged on nearly as significant as the search we're now that there wasn't another surge and at that point, we did the quite a bit of movement in the maintenance schedule in parts by the behavior out of the customer base.
We did not see and have not theme that the same movement in behavior as we've gone through this most recent surge as the customers appear to be focusing on okay. We're going to have some ups and downs over the next few months, but at the end of the day. The vaccine will the distributed the pent up demand for leisure travel and we want to be ready for that in some of its.
Anyone so while the the on I would say the level of expectation over in the of increase in summer 21 travel over summer 2020 varies by customer overall of the customers expect to have a better summer and 21 than it did in 2000 and they want to be ready for it.
Okay, and then can you just walk us through maybe the three legs of your commercial business, where each one is kind of on on the road road to recovery and then structurally what's changed about each of the three in terms of kind.
Kind of how big they can be on the other side of this and whether they're going to be structurally smaller for a period of time if that makes sense.
Sure I mean in terms of overall size I would I would go back to what we mentioned earlier.
We expect to be on a relatively stable revenue environments until you see a meaningful increase in and flying activity.
But at the same time, we remain very focused on continuing to improve our margin and that stable environment. If I take the three areas of the <unk> of the commercial business.
Some of the parts business, both new and used parts as we mentioned earlier, we've seen relatively stable activity. We have had what I would call kind of higher highs. If you will you know during the last of the last few weeks, which is oh encouraging but it's still overall, we would expect stable activity in the.
In the commercial parts business coming out of the crisis as we've talked about we we definitely expect increased demand for the the U.S. on business. We're really excited about our partnership with the with fortress. That's one of many initiatives we have going on right now on the U.S.M. side, but I would expect that business to.
The.
You know potentially the structurally larger than it was a pretty common depending on on how the man shakes out.
Similarly on the new parts distribution business, we continue to add on new distributor ship. There are a number of opportunities out there that we are evaluating for new new parts distributor ships with the with different Oems much like the airlines the Oems have the they're taking a look at their approach to the aftermarket.
And similarly, a as they think about their cost structures. We are seeing some interest from Oems that previously might not have considered the distribution partner now they are looking on the distribution partner and so we are evaluating that those opportunities and.
And we think that that business could also emerged larger thanks to new business wins as well as same store sales. If you will increase on the agreements that we had prior to coated.
In the MRO business.
I would say that you know we feel very good about the footprint that we have we took out capacity.
Which is a very difficult decision that we took out capacity by closing our dilute the facility as well as the rationalize our footprint inside of other facilities that are still on the network and we believe that ultimately of we'll get a better yield out of that footprint than we did the pre co but because of some of the changes that we've made and finally on the commercial pro.
Grams business.
That's a business, where we've made a lot of changes over the last several quarters as we've talked about we've exited underperform exited or restructured underperforming contracts.
The majority of that work is now behind US we book, we feel good about the remaining contract portfolio and I believe we talked about this last quarter, but on.
Now that market had seen a lot of pricing pressure pre co. The.
And you've seen a number of the the participants in that market make moves either the exit the market entirely are also like us exit underperforming contracts and we yes. We believe that you could see pricing in that market reef that protocol, the and to the extent that the does the we believe the weekend.
On earned a return of growth will be a participant in that market.
That's great of John Fair to say that kind of the the highest margin leg for you all of the bigger in the two lower margin legs will probably be smaller for a period.
Yes.
Okay and then just just two quick follow ups on MRO and have you seen any indications from airlines that they may be may be able to outsource more than they were able to pre cove. It in terms of concessions that they've been able to get and then.
In terms of what you've done to rationalize capacity is that enough to to fix the margin challenge that you all had a day MRO pre cove, it or do you still space. Some of the challenges that you had I guess pre co of at once once we're through this thank you.
Sure in terms of the in terms of work I mean, all of our customers are reevaluating their out of their operating models. I mean, you have to you are going through a shock like we've we've been through so we're having a variety of of conversations the both with existing customers and as you point out with customers that made out of pursued announced.
The first model not to the extent that they may consider now so there's a lot there's a lot of moving parts there.
And then as it relates to the operating efficiency inside of the hangers on.
Yeah, we feel very good about the changes that we that we have made we believe the footprint. The rehab is the right footprint.
On to take the work that we expect to get over the next few quarters as well as a as well as the increased volumes of the overall market recovers and we do expect.
On a much greater yield out.
Out of the labor hours that we produce based on the efficiency that we've done on a we've built in.
You know again, there there's a lot of moving pieces, there and we're extremely grateful for the support of our customers through the.
And were very excited the continue to provide the maintenance services to them as they recover.
Great. Thank you.
Thank you.
And our next question comes from Ken Herbert from Canaccord. Your line is now open.
Hey, good afternoon, John on Sean.
Hey, John I, just wanted to first the if you can provide or what other details you can provide on the agreement with fortress for the CSM. The five on the seven be engines and I guess specifically.
Timing you expect to start to see some of the engines come through assuming we start to see some demand at some point for the material and and how we should think about the ramp of disagreement as it relates into your broader sort of U.S.M. opportunity.
Sure.
Thanks for asking about that we're very excited about the partnership of fortress, we've worked with fortunes for for many years and have a great respect for what the team over there is doing in the industry and this the disagreement really plays the bulk of our strengths they've got a of very large and growing the engine lease pool and we are the you know the number one.
The spent in the the U.S.M.'s David So the agreement up basically calls for us to to manage the engines through a tear down profit or out of out of their engine pool and we have complete control over that management. Some of the material will be sold back to fortress for use in there.
They are on a.
In their own engine build and the rest of the material will be sold by the end of the aftermarket and there are on a volume of commitments the between us and fortress and those volume commitments will meet the will be a a meaningful increase the through our aftermarket parts activity and the other core engine black.
Forms of because you know so we're excited to to be a participant in the even bigger participant in that market.
As it relates to timing we are we would expect a volume the on to see a volume later this fiscal year and then it would grow.
Grow throughout our EPS why 22.
Okay, and then as I think about is the say would you consider this sort of an asset light agreement or are you actually going to be committing working capital to maybe buy some of the engines on materials ahead of time.
It's an asset life agreement will be investing in repairs, but but not the assets themselves.
Okay, great and as I think about it if we sort of walked back from a you know hopefully a a summer or mid 21 recovery and traffic can you speak about airlines behaviors is it is it fair to say that you would see this first in in your Emrose schedules.
And then maybe second day in and.
On the surplus material and then your distribution business might be the last the see the uptick is airlines actually start to to buy material again or is there a better way to think about the cadence of the impact on your business ahead of what should be an improvement.
You know historically would I Storch way, what you just said I would agree with that you know coming out of this downturn just because it's been you know so so broad and extended and because of the on.
The the the.
Significant deferred maintenance, particularly particularly on engine.
That has built up over the last several months you know it's possible that we could see a concurrent recovery between the parts business as well as the the heavy maintenance business or the parts business could lead the recovery of right.
Right now the loading that we have on the hangers is relatively consistent is relatively consistent over the next couple of quarters, but the as the as our customers have better visibility into their demand going in the summer 21, you can see that change as well.
Okay. So it sounds like based on that comment on I don't want to put words in your mouth, but it sounds like you don't view Green time.
On the engines, the particular as sort of a major overhang to the pace of the recovery.
Well I think there I think there were burning green time, now and Oh.
Yeah and so.
We're looking at.
Ultimately of that Green times come down the deferred ballot.
Balance is growing if you will and that would require more parts sooner.
Okay. I guess the question is that the for doesn't sort of spill into their night not able to defer theoretically for much of 21, if you see a recovery at some point it earlier on 21, it sounds like that that green time of that deferred opportunity will largely have run its course theoretically if we do get a recovery of mid 21.
Yeah, I mean, a a you've got a lot of moving parts, there, but but the.
That could be true.
Okay, perfect all right well, thank you very much.
Thank you.
And our next question comes from Michael share Moly.
The list your line is now open.
Hey, good evening guys. Thanks for taking the the questions here good day good margin performance.
John I guess just to maybe stay on on kind of Ken's line of questioning and net recovery I know you said the revenues.
Like me stay stable until we see a pickup in travel utilization, most likely takeoffs and landings and you just kind of said that loading books consistent but it's if these airlines and your customers are going to be ready for balance knock on wood of normalized 21 summer should we see on a pretty big uptick in.
Activity ahead of that and the as you guys look at it you know do you think like the May quarter, you know ahead of that.
Business line season, you start to see that revenue inflection before we see the uptick in kind of all of that pent up demand and traffic a uptick.
You very well could.
You know our stable outlook right now reflects what the commitments are that we have you know to the extent that the customers of the increase booking and it's the that that demand increase then you're absolutely right. There could be more demand I don't know that any of our customers right now are expecting a return to normal levels of flying in summer 21.
And I think that you know, they're expecting certainly an increase in 21 over 20, but you know.
I think many of them are still you know have modest expectations, having said that though.
You know I mean, the the situation continues to evolve very quickly I know our customers the.
Yeah.
Yeah. The bookings the cancellations are happening in real time for them and so they don't have a lot of visibility into in the demand. So I think as soon as a a into the have a clear picture of summer 21, they absolutely a good the could be calling for more maintenance of more parts.
Got it yeah and by no means that I suggest that a normal 21 or just yeah, I guess what the.
The customer conversations I mean things or what the surge I mean things are going to be bad here on December might get worse in January February I mean, how would these conversations can you give us any insight as to how things are evolving I mean are there.
Are there more areas of risk that you see I mean, you talked about the loading but I mean are there pressure points at some of your customers are they all pretty much of planning for okay capacity demand is going to be weaker for the next couple of months, but we're we're thinking beyond the short term impact so are the thinking.
More along the lines of pay our plans are pretty stable on from regardless of what happens or is it just still totally fluid out there.
I think that I think what you just said you know the next the last thing that you said, it's okay. It's going to be on it's going to be a a bit of an up and down patch here for the next few months, but we need to look past that and be ready for the summer 21, and I I believe that at least the commitment the day.
We have made to us that they are based on what I'll call kind of the you know a conservative case of what they expect summer 21 flying to be in other words, they're committing to us because they know that for example, the maintenance business, we need to have solid lines of maintenance the keep the team together and keep them working and so right now they've committed.
The level of loading that they know they can hit to the extent that they end up with the better summer. They may require more Megan we just haven't seen that that order book form of yet.
Got it and then just back to the on the MRO you talked about the the footprint the efficiencies there better.
Better yields is there also I mean at one point LIBOR was extremely tight you know are you getting more experienced the mechanics and there is there any.
Benefit you're seeing from.
Just hourly wages, you're having to pay or or is it just strictly tied to those those footprint reductions that's helping your yield there yeah.
Yeah. Good good question you know so far.
Wages of remain relatively stable, we have I think done a really nice job of the of retaining and recruiting.
Much more experienced workforce and the that experienced workforce is delivering.
Great results for our customers on in terms of quality and turnaround time performance on it so as I mentioned earlier, our reliance on you know contract labor is a is much reduced from where it was pre called it and that is a on a ratio that we are really focused on preserving and that's one of the reasons during the time that.
The main reason, we took care of that funding. It's a you know we've done everything we can whether we're furloughing people are you know on the in the worst case, we've had the let people go of thinking maybe one day, we did in the back of we've done everything that we can.
To to treat our people of the best as we can throughout this period.
As Sean mentioned, one of the decisions that we made a few weeks ago was to restore salaries and benefits for our workforce.
So then at all levels on the company.
Whether you're in an office or in the hanger.
The you Youre paying current restored and we can keep the team together. So we're doing everything we can to out to treat our people well and I think that's going to serve us well on the marketplace. As we go out of we continue to out to build the workforce and we'll be able to get the best talent available.
Got it that's helpful. And then just the last one just back to that for Chris agreement.
I think you talked about investing in repairs are also selling parts and any color on the margin profile I mean, I would think obviously the part sales would be much higher margin how should we think about the the repair component there or is it more higher margin than your typical MRF given by the obviously engine accessory type repairs or sounds like it.
Is going to be a margin accretive opportunity, but any more color you can share there.
Yeah, I would just day that you know, we don't want to get into the margins. The particular details around that specific agreement, but I would say again that we are we're excited about it and it will be a it will over time become a meaningful part of our of our U.S. on business.
Okay got it thanks guys.
Thank you.
And I'm showing no further questions I would now like to turn the call back over to management for further remarks.
Okay, well. Thank you very much we really appreciate everyone's time and interest in the states day, if and when I wish everybody a happy holiday.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
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