Q3 2021 AAR Corp Earnings Call
Okay.
Good afternoon, ladies and gentlemen, and welcome to a our fiscal 2021 third quarter earnings call.
He joined today by John Holmes, President and Chief Executive Officer, and Sean Gillen, Chief Financial Officer.
Before we begin I.
I'll remind you that 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 company's news release and the Doctor section of the company's form 10-K for the fiscal year ending may 31st 2020.
We're providing a quality things the company assumes no obligation to provide.
I would like to meet to affect each ex circumstances or anticipate it.
Or unanticipated events.
This time I'd like to turn the call over to AAR as President and CEO John Holmes.
Great. Thank you very much and good afternoon, everyone. I appreciate you joining us today to discuss our third quarter fiscal year 2021 results.
I would like to begin the call by once again, recognizing our employees for their unwavering commitment professionalism and flexibility have allowed us to continue to support our customers without interruption over the past year I am grateful for their loyalty and sacrifices and thank them all for what they have done and continue to do for AAR.
Turning.
In the quarter.
Our sales decreased 26% year over year from 553 million to $410 million and our adjusted diluted earnings per share from continuing operations decreased 45% from 57 per share to <unk> 37 per share.
Our sales to commercial customers decreased 42%.
<unk> and our sales to government and defense customers increased 4% for the quarter sales in government to government and defense customers were 49% of our total sales.
As we mentioned on the last earnings call, we expected relatively stable revenue, which is what we saw in this quarter with sales up 2% sequentially.
And.
We did see a sequential increase in hangar activity due to increased demand supporting anticipated leisure travel.
And our commercial parts activities revenue was relatively stable, but we were encouraged to see orders across a broader range of customers during the quarter than what we saw in Q2.
Our government businesses.
In MRO, which have performed very well over the past year continued their strong performance delivering another quarter of year over year growth.
Regarding profitability, our adjusted diluted earnings per share from continuing operations were up 19% sequentially, reflecting our continued margin improvement progress on.
On an adjusted basis.
<unk>, which excludes the benefit of the cares Act our gross margin improved sequentially from 13, 9% to 16, 1% and our operating margin improved from 4% to 5%. We have now more than doubled our adjusted operating margin over the past two quarters, while operating in a stable revenue environment.
We are also proud to have fully reinstated salaries and 401 K benefits at the beginning of the third quarter, which had been a priority for us as we look to attract and retain top talent.
Even with the compensation restoration, we were able to still deliver a full point of adjusted operating margin improvement.
Net.
That improvement reflects the operating leverage that we've created through cost reductions efficiency gains and portfolio reshaping over the last year.
Turning to cash once again, we were cash flow positive in the quarter, even while making investments in new business wins.
We generated $18 million from operating activities from continuing.
And remain in a strong balance sheet position with one one times net debt to adjusted EBITDA.
Speaking of new business. We also continued to secure and execute new wins during the quarter, we expanded our distribution relationship with GE subsidiary unison.
A five year program from the U S Air force to provide repair.
<unk>, we're all about 16 accessories and extended our support of the Navy's aged 60 Seahawk platform for an additional seven years. We also began operations on our previously announced Honeywell 737, Max EBIT contract.
With that I'll turn it over to our CFO, Sean Gillen to review this quarters.
As a result in more detail.
Thanks, John our sales in the quarter of $410 $3 million were down 25, 8% from $142 $8 million year over year, driven by the reduction in commercial passenger flying activity due to COVID-19 sequentially.
Sequentially sales were up one 7% with commercial sale.
<unk> up 7% driven by MRO volumes and government and defense sales down three 3% driven by the scheduled reduction in activity on our program to deliver two C 40 aircraft to the U S Marine Corp.
Gross profit margin in the quarter increased to 21% from 11, 8% in the prior year quarter, driven primarily by the cares.
<unk> payroll support.
On an adjusted basis, excluding the cares act support and other items gross profit margin was 16, 1% consistent with the 16% in the year ago quarter. Despite the significant decline in sales.
Sequentially adjusted gross profit was up meaningfully from 13, 9% to $16.
1%, reflecting the actions we have taken to reduce our indirect costs and drive efficiency.
Regarding expeditionary services specifically.
Gross profit margin increased to 17% from 4% in the prior year quarter, driven by the divestiture of the composites business and improved performance at the mobility operation.
SG&A expenses were $44 $9 million per the quarter on an adjusted basis SG&A was $42 8 million or 10, 4% of sales down $9 million from the prior year quarter, reflecting the reduction of our overhead cost structure.
With respect to our accounting for the cares Act payroll support we are fully recognize our deferred credit.
In Q3, and we will no longer have income associated with the cares Act support.
We have an $8 8 million promissory note associated with the cares Act, which we expect to repay during the fourth quarter.
Also we continue to have certain foreign subsidiaries that are eligible for stimulus provided by foreign governments.
Consistent with prior quarters government subsidies.
Including the cares act are reflected in our GAAP income primarily as a reduction in our cost of sales. However, we exclude these benefits from our adjusted results.
Other adjustments during the quarter included $4 million of loss provision and exit costs for commercial programs contracts $4 5 million of which reduced sales.
In addition, there was a gain of $4 $3 million related to a legal settlement, which we have excluded from our adjusted results.
Also during the quarter, we reached a tentative agreement with the department of Justice to settle the investigation of air lift under the false claims act for approximately $11 5 million.
As such we recognized a charge in the quarter of $4 2 million.
In discontinued operations.
As a reminder, we completed the exit of our airlift business in the fourth quarter of last year.
In the quarter, we generated $17 $6 million of cash in our operating activities from continuing operations, we reduced inventories by $21 million from our second quarter as we continue to focus on working capital.
Management.
Our net debt at quarter end was $108 4 million down from $112 1 million at the end of Q2 and from $171 1 million at the end of Q3 of last year.
In addition, our accounts receivable financing program has decreased by $37 $2 million over the last year from $85 6 million.
We ended the year ago quarter to $48 4 million.
Our overall leverage and liquidity remains strong with net debt of one one times adjusted EBITDA unrestricted cash of $99 2 million and unused capacity under our revolver of over $400 million.
Thank you for your attention and I will now turn the call back over to.
John Thank you Sean.
Overall, we are encouraged by the widely reported recent increases in demand for domestic leisure travel and we remain optimistic about the broader commercial market recovery.
We expect modest sequential improvement in Q4 and continued improvement thereafter as the vaccine is distributed and current travel restrictions.
At impacting some of our larger international customers are lifted.
That occurs in our revenue recovers, we remain committed to leveraging our current cost structure to drive continued margin improvement. In addition, our balance sheet puts us in a very strong position to be able to funding growth, we expect to make investments in our U S M and distribution.
Which are <unk> as well as to continue to invest in our technology and digital initiatives. These actions along with the continued strength of our government business and the early signs of a recovery in our commercial markets give us increasing confidence that we will emerge from the pandemic as an even stronger and more profitable company.
Enacted that I'd like to turn it over to the operator for questions.
Thank you again, ladies and gentlemen, I'd like to ask a question. Please press Star then one when you've had some telephone to ask a question. Please press Star then one our first question comes from Robert Spingarn of Credit Suisse. Sir Your line is open.
Hi, good afternoon.
Hey, Rob how are you.
Good thanks.
Nice quarter from you guys and John I wanted to talk a little bit about some of the trends here.
Maybe just sequentially I know you don't like to break out the business is too much but if we think about the sequential performance from Q2 to Q3 in terms of the commercial business.
But its versus MRO.
I think you said it was at a 2% growth overall in commercial between the two quarters.
So at a 7% sequential im sorry, 7%, how do we think about that in those two different businesses, what's what's stronger.
Yeah sure. So we did see elevated and MRO.
ROE we saw elevated maintenance activity go on from Q2 to Q3.
And in the parts business. It was relatively it was relatively stable.
Typically you do see maintenance activity pace ahead of parts requirements, because repairing aircraft generate parts requirements. So that's.
As part of its surprising to us necessarily but.
Growth primarily came from from the <unk>.
Moro segment.
On the parts side, though as I mentioned, we are encouraged that.
That we saw a broader customer base returning to the market on the parts side, both in new parts sales in <unk>.
Our sales if we look at the prior couple of quarters, there was quite a bit of activity being driven out of the freighter and cargo market and we thought the names candidly that we hadn't seen in a while from the passenger market come back in the quarter all of that still added up to relatively stable performance, but it was encouraging to see some of those customers come back.
Yes on the U S.
What else can we say about part part out activity.
Based on what you've seen.
And so.
That would kind.
Kind of varies by asset type. So if we look at the freighter market the engine and airframe that support the freighter market.
We've got very strong demand and the supply at this point because of all the conversions going on is actually relatively tight if we look at the broader narrow body market. The current generation <unk> hundred Twenty's current generation 737, Mg we are seeing increasing.
Cash from customers that had previously not had an interest and use them as well as I mentioned.
Customers that we haven't heard from it'll allow come back into the game. So we expect increases in U S and demand there but.
We do differently than what we see in the freighter and cargo off market.
Interim or supply.
Coming available.
In the broad or narrow body market.
Yes, I was going to are you how is the supply on the on the passenger side is it there are airlines or owners, making decisions to part out some of these.
<unk> or maybe <unk>.
We see I imagine older aircrafts as well they are sitting there in the desert.
Yes, I think so.
Yes.
Overall that activity the kind of the line from grounding to retirement from part out has taken a bit longer to occur then we might have thought a couple of quarters ago, but we still believe youre going to see increased.
Oral ability overtime.
Our focus certainly is we want to pay attention to those macro trends, but our focus is on our own agreements that give us a proprietary access to material to the to support the demand that we see ourselves in the fortress deal that we announced last quarter is an example of that.
Okay, and just one more on this.
If you look at the fleet of aircraft that you cater to in your commercial business is there any way to estimate what percentage of those are flying domestically here in the United States versus those that fly international routes.
We'd have to look at that.
Okay, Alright, and then Sean just on.
On the margins I wanted to ask you if you could just delve into some of the improvement it sounds like its overhead driven.
<unk> taken out a fair amount of overhead how much of that reduction is going to be sustainable through the recovery.
Yes, we would anticipate that the vast majority of overhead takeout is sustainable.
If the recovery in kind of committed to that reduced overhead cost structure, we are seeing some efficiency improvement.
In our operations.
But then there's also the reduced indirect and that shows up in the gross profit and then the reduction in SG&A you can see in the quarter as well.
So some of that will come.
All through the volumes recover, but we do think that the vast majority will stick.
So you should be able to hit higher margins than before at some point when we get well into this recovery and volumes are there.
Absolutely.
Okay.
Thank you Paul.
Thank you. Our next question comes from Ken Herbert of Canaccord. Your line is open.
Hey, good afternoon, John and Sean.
Hi, Ken.
Hey, I just wanted to start out.
Put you on the spot a little bit our fourth quarter revenues going to be up for you I mean youre going to anniversary.
Obviously, the significant drop you saw in the fourth quarter of fiscal 'twenty. So how should we think about the sequential movement into the fourth quarter or do we see positive revenue growth for the first time.
We as we mentioned, we expect a modest improvement sequentially from Q4.
For two from Q3 to Q4.
Not ready to necessarily call year over year improvement, but.
It's pretty close.
Okay. Okay. That's helpful.
And just to follow up on the on the <unk>.
Mauro discussion are you.
It sounds like Youre seeing an uptick in <unk>.
And backlog how would you how would you think about sort of where you are at your at your hangars now in terms of utilization or or maybe you don't lines that are there that are booked here through the fourth quarter I mean, how do we think about any excess capacity you may.
They have or how is that trending.
Yeah.
So overall, we are encouraged by the level of demand that we're seeing for hangar space.
Right now.
One thing that we.
We mentioned before that we do have some international activity that is pacing behind what we're seeing in the U S and as you know we have a.
A couple of.
Fairly meaningful operations up in Canada, and Canada has been closed like what youre seeing over in Europe. So those operations still have a ways to go to get back to pre COVID-19 levels, but in the U S. We're definitely seeing a recovery pacing ahead.
As Sean indicated.
Very focused on our operating efficiency.
And what we've driven over the last several quarters is a much more efficient and productive and higher quality operation in our MRO.
Facilities than what we saw before before Covid.
And so we're being very thoughtful and very disciplined about how we bring back work across the network. So that we preserve the gains that we've made in the past few quarters.
One other point on MRO.
You have a mix of <unk>.
Work that is being done right now.
Two.
To prepare for what we expect will be a busy.
Summer travel season or be the leisure travel season, but you've also got some deferred maintenance that starting to come through and as we think about Q4 going into Q1, it's likely that you wouldn't see the typical seasonal decline in the hangers.
You have historically because airlines at least in the U S are going to use that time, most likely two to catch up on some deferred maintenance.
Okay. Okay. That's helpful is the demand such that John you were able to see any any relief in labor rates or how do we think about pressure.
Pressure, there and in the supply demand balance.
So far it's been relatively consistent throughout the throughout.
Throughout the entire pandemic.
Okay, perfect Alright, I'll stop there and pass it back thank you.
Great. Thanks, Dan.
Thank you again, because I can ask a question please press star.
Our next question comes from Joseph de Nardi from Stifel. Your line is open.
Good afternoon, guys, Sean just a quick one for you you mentioned adjusted gross margins were 16, 1% can you give us that on kind of commercial versus defense is commercial a little bit below that in defense is a little.
Above that so that the right way to think about it.
That's right you know commercial's, a little bit below defense is a little bit above you'll see some of that detail in the Q that are filed here shortly.
Great.
And then John you spoke about this a little bit but can you just talk about kind of your exposure domestic versus international on the commercial side.
<unk>.
As you mentioned it seems like U S Airlines are kind of getting capacity back to pre COVID-19 levels, a little faster than international like where are you on U S commercial relative to pre Covid and where are you on international commercial relative to pre COVID-19 at this point.
Sure historically.
Eric Lee the business mix has been relatively 65% domestic and 35% international.
As it relates to the domestic we still have a ways to go to get back to where we were.
Relative to pre COVID-19 levels, and that's across both MRO and parts business in particular.
Sure.
The International segment as you mentioned is pacing far behind due to the restrictions that are in place China. China. Domestic is is almost back to pre COVID-19 levels, but the rest of Asia is a very very soft in Europe remains a very very soft relative to pre COVID-19 levels.
Okay. That's helpful. And then just on the on the fortress deal. It's clear that kind of you all of you that it's pretty important that I suspect some investors are struggling to quantify that opportunity exactly so.
Can you just kind of give your best shot at that like if you had had the agreement in place pre COVID-19 what would that of.
For the business like how much would that have helped maybe yeah.
Yeah.
I appreciate you asking that we are you know I don't want to get into specifically quantified that that deal, but suffice to say it.
Would have been a meaningful contributor to us and we expect it to be a meaningful.
Men contributor to the trading results to the U S. M result fortress has been a great partner for many years moving that joint venture with them was really a nice next step in the relationship and we are.
We have received the first.
Set of material from them so it will be a.
I would say a small contributor this quarter and we expect growth.
Going into next fiscal year.
Okay. Thank you.
Okay.
Thank you. Our next question comes from Michael <unk> of truck share.
Your line is open.
Hey, guys.
Good evening. Thanks for thanks for taking my question and nice results here.
Maybe just back to the I think what Rob was asking on the margins.
<unk> gross margin of 16, 1% really a strong number there and it sounds like youre not getting any benefit from lower labor rates.
It may.
Maybe give us a sense I mean, John if we look back you know a year ago you were doing.
100 million more plus in revenue.
Gross margins were pressured obviously there were some labor challenge but.
Structurally you talked about more efficiencies I mean, what specifically is driving that.
Can you if I look at it now I mean, it sounds like you've got a little bit of a mixed headwind with stronger MRO. So presumably one some of that parts volume kicks in it seems like you should have more runway here with with parts with volumes, maybe more efficiencies with the market getting in line, but can you give us maybe dig a little bit deeper.
And tell us exactly how youre, putting up these margins with the top line pressures.
Sure absolutely and again, we're very very pleased with the progress that we've made in a short amount of time.
And as you know we've been taking a number of actions across the company and in a number of different areas to drive this margin improvement that includes exiting underperforming.
Product lines underperforming contract, we've consolidated a number of facilities and then we've just taken a G&A head count out.
Also deploy technology in certain area. These were initiatives that were underway pre COVID-19 that are now kicking in and helping driving efficiencies. So we definitely see more runway as it relates to.
The margin improvement.
As we see as we see revenue recovery.
And the MRO business. For example, you mentioned the labor Yeah, it's definitely not coming through labor rate relief.
We have really focused on as we retool the labor force.
Sure.
That we hung onto and took care of our most experienced mechanics, and we've got to focus now on limited the amount of contract labor that we used in the operations so that we.
We have the most experienced employee base, who are able to turn a higher quality product and do it more efficiently and what we saw before and so on the <unk>.
Micro business, which historically had been one of our lower margin performers received a nice gains there in terms of the <unk>.
Our income performance and then you're absolutely right as the parts business starts to return that historically has been a higher margin business for us and once that starts to kick in at the revenue line, you'll see that flow through operating margin.
Margin as well.
Got it that's helpful. What about just on those parts on USF, you mentioned more supplies coming available any any detail you can give on pricing at all I mean.
Talking more supply potentially flooding the market or is it still fairly price competitive and a challenge to get your hands on the good materials.
Real out there whether it's some of the legacy narrow body or current generation anything you can say there on pricing.
Yes, I wouldn't I wouldn't want to get into that just for competitive reasons.
But.
I would just say that you really see a lot of variation between between asset type at the moment.
Okay. Okay.
You mentioned.
Some international facilities locations you have.
The other potential government subsidies are you planning on taking any other subsidies going forward.
Here in the U S. A net represents the majority of the subsidies we taken we were eligible to receive.
<unk>.
Additional cares money under the original program as well as under the New program given the strong performance of the company and our cash generation, we elected not to participate in those two U S options.
Canada and our facility in the Netherlands. For example, there are programs still available there and we continue.
Whether or not we will.
They all ourselves to those going forward.
Got it got it last one from me just you've got a lot of unused capacity I think you said $400 million what are you seeing in the marketplace.
For potential assets out there do you think there's some good opportunities are you looking to be sort of a consolidator here.
To a value looking at the marketplace.
Yes.
We're paying very close attention to what's available what would be coming available what we would like to be available.
And to the extent that we find the right opportunity we feel good about being in a strong position to execute.
Got it got.
Thanks, a lot guys I'll jump back in the queue.
Thank you. Thank you.
Our next question comes from Josh Sullivan of the Benchmark Company. Your line is open.
Hey, good afternoon.
Josh can you can you just talk a little bit about customer mix I mean, just.
As you've seen some of the recovery.
Got it any change in new customers or old customers. It just just curious what that might look like at this point.
Sure.
In the parts business the.
The majority of the activity over the last couple of quarters has really been driven by the cargo market.
We don't see that changing we think that's going to be a strong market.
Have you time, but in this quarter for the first time in a while we saw.
Uh huh.
Meaningful inquiries and in some cases actual orders out of our larger historical passenger so we see them kind of re entering the fray if you will in the parts business.
In the MRO business as we mentioned.
For some Canadian operations have been have been quieter.
Quieter than the U S operations, but you are seeing.
<unk> domestic.
To support domestic leisure travel that activity increasing out here in the U S.
And in the MRO market.
Got it.
Good.
The.
And then they've got.
As you've seen from the numbers. The government business has remained very strong this entire time, where you put up three quarters in a row of year on year growth in the government business and we remain very encouraged by the pipeline of opportunities that we see there.
And then just on the government business.
The feedback from the <unk> business or the helicopter.
Contract that you got how is that performing.
<unk>, new territories or do you expect to open new operation centers going forward.
Yes.
The <unk> contract the <unk> contract is actually performing very well, we're really happy with the way that's gone over the last.
Forget the several years in our customer the department of State is also very happy with our performance.
That has turned out to be a much more dynamic program than you might have thought that we might have thought when we took it on and as much as you do have.
Locations that open and close with a fair amount of regularity. So if we go back to the early days.
Graham we were publicly disclosing opening and closing every time a base you know.
Every time, we went into a new location, we realized that that was going to be a more frequent event that we thought we moved away from it but.
There has been a.
Up and down operational tempo between locations, but the overall revenue contribution and income contribution of that program.
So the probe has been very stable for the last several quarters.
And then just one last one I mean are you expecting any additional state department funding to flow into that contract vehicle just as budgets come together here do you have any visibility into that.
Unclear unclear right now, but no no meaningful.
As expected one way or the other at this moment.
Okay. Thank you for the time.
Great. Thanks, John.
Thank you. Our next question comes from Joseph de Nardi with Stifel. Your line is open.
Yeah. Thanks, Sean I think pre Covid you guys have been talking about maybe 10% to 11% SG&A as a percentage of sales.
Change is still kind of how you're looking at the business going forward.
Yes.
That's right obviously as the recovery occurs in my comments on keeping this cost structure, you'll see improvement on that once we start to see the top line recovery.
Okay, Okay, and then maybe John or Sean just on the deal.
Doj settlement.
Kind of.
And gone at this point or are there any contingency is there any other kind of considerations to keep in mind with that going forward.
Once we reach final agreement with the government it will be done and gone, but we still have a little bit of work to do to finalize the settlement.
Thank you.
Right.
Thank you next question comes from Ken Herbert of Canaccord. Your line is open.
Yes.
Mr. Herbert Your line is open.
Yes, all right. Thanks John.
I just wanted to follow up in prior quarters you talked.
About.
More outsourcing by airlines sort of coming out of a crisis. Like this are you expecting sort of a similar playbook now and I guess my question would be if you want if you do expect more outsourcing maybe airlines, especially around the MRO side is your comments around being more selective in the work you take on.
John maybe implying that it's for you it's not as much now about sort of the topline growth in MRO and taking advantage of those opportunities as it is making sure. It's the right opportunity to maybe per on the side of margin expansion.
It's definitely the latter I wouldn't necessarily relate those two things to more work hitting the market as a result.
A outsourcing.
But the latter is true we are.
We focused on maintaining and expanding the margin gains that we've seen.
Over the last few quarters and that leads to just being a bit more selective about the work that we take on and really focusing on increasing the throughput on a smaller footprint than.
Pre COVID-19 as you remember we did close one of our sites. Unfortunately difficult decision Duluth, but that has has allowed us to achieve more efficiency across the remaining network.
And as you think about the increased focus maybe on margins does it ever reach a point, where maybe the benefits.
Then we had the MRO business in terms of customer face time, and the other synergies you've talked about.
Maybe are no longer quite worthy investments I mean, how do we think about the potential for a more significant shift in mix of the business moving forward.
We we still believe in the <unk>.
Between the MRO business and the rest of our businesses and certainly.
Even better about that as we book to continue to improve the margin performance of the MRO businesses.
That's a very dynamic market.
And so we always going to be on our toes. There in terms of how we win and how we perform.
<unk> goes on there from a competitive standpoint, but.
We were.
Phil.
Fans of the connection between MRO and parts of the programs business.
Alright, Thank you very much.
Thank you.
From an what I'm showing no further questions at this time I'd like to turn the call back over to Mr. Holmes for any closing remarks.
Great well. Thank you everybody really appreciate the time and the interest and stay safe and look forward to talking again next quarter.
Thank you ladies and gentlemen, this does conclude today's conference. Thank you all for participating you may all.
All disconnect have a great day.
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