Q2 2022 AAR Corp Earnings Call
Okay.
Good afternoon, ladies and gentlemen, and welcome to Aar's fiscal 2022 second quarter earnings call. We're joined today by John Holmes, President and Chief Executive Officer, and Sean Gillen, Chief Financial Officer before we begin I would like to remind you that the comments made during the call may include forward looking statements as defined in the private Securities Litigation Reform Act of 995.
Forward looking statements involve risks and uncertainties that could cause actual results to differ materially from the forward looking statements. Accordingly. These statements are no guarantee of future performance. These risks and uncertainties are discussed in the company's earnings release and the risk factors sections of the company's Form 10-K for the fiscal year ended May 31, 2021, and Form 10-Q for the fiscal quarter ended August 31 2021.
In providing forward looking statements. The company assumes no obligation to provide updates to reflect future circumstances or anticipated or unanticipated events.
Certain non-GAAP financial information will be discussed on the call today, a reconciliation of these non-GAAP measures. The most comparable GAAP measures is set forth in the company's earnings release.
At this time I would like to turn the call over to Aar's, President and CEO John Holmes.
Great. Thank you very much and good afternoon, everyone. I appreciate you joining us today to discuss our second quarter fiscal year 2022 results.
Before discussing the results I would like to comment on the overall environment as you can.
We're now seeing the spread of the omicron variant, which is resulting in government restrictions that are impacting commercial passenger traffic while the overall commercial passenger traffic market is recovering the delta variant and now the omicron variant highlight that that path to full recovery will not be a straight line.
Despite this dynamic environment, we have remained focused on our own execution and are proud of the multiple quarters of margin expansion and strong cash flows that we have delivered.
Turning to this most recent quarter, our sales increased 8% year over year from $404 million to $437 million and our adjusted.
<unk> diluted earnings per share from continuing operations increased 71% from 31 per share to <unk> 53 per share.
Demand for our MRO services has remained strong even as our MRO customers deal with changes to the bookings and schedules. They have remained focused on keeping a maintenance supply chain running smoothly.
Our customers have also been supported and recent price negotiations as we look to address the tightness in the labor market together.
Parts supply, which is our highest margin activity had stable volumes throughout the quarter, albeit down from the levels. We saw early in Q1 before the onset of the Delta Varian.
While overall the supply chain that supports our own operations are functioning well, we have been extended turnaround times from some of our repair subcontractors as well as freight delays, which did cause some sales to move from Q2 to Q3.
Regarding earnings we delivered another quarter of margin expansion as our adjusted operating margin was six 1% for the quarter sequentially. This is up from five 5% in the first quarter. Despite a decline in sales even more importantly, our margin exceeded pre COVID-19 levels, even though our top line is still down significantly.
To illustrate that our adjusted margin this quarter increased from five 6% to six 1% compared to two years ago prior to the pandemic, even though our adjusted revenue was down $127 million over that same period.
This year's this quarter's margin performance continues to validate the actions that we've taken over the past two years to drive efficiency in our operations prioritize more profitable offerings and exit underperforming activities, we expect.
Continued margin expansion as our commercial parts demand fully recovers.
Turning to cash we had another strong quarter as we generated $16 million from operating activities from continuing operations.
We also continued to reduce the usage of our accounts receivable financing program, excluding the impact of the AAR program, our cash flow from operating activities from continuing operations was $26 million.
Over the last six quarters, we have generated a total of $142 million of cash flow from operating activities from continuing operations.
Regarding new business during the quarter, we announced a five year renewal of our fly Dubai with Flydubai to provide power by the hour component support for its fleet of $33 733, 737 injuries. We also announced a sustainability initiative with fortress transportation and infrastructure under which we will.
Contribute a percentage of all U S and sales from our CFM 56 partnership.
<unk> carbon offset credits on behalf of our customers.
This initiative, both reflects our commitment to helping our customers reduce their carbon footprint and the fact that U S. M. As a low cost green alternative to purchasing new parts.
Finally, subsequent to the end of the quarter, we announced a 10 year $365 million contract with U S. Air Force to provide depot level maintenance and repair it's primarily for the F 16 aircraft based in Europe.
We have been supporting F 16 for decades, but this program takes that support to a new level of complexity and duration of this contract is a meaningful step above our prior FC F 16 support and will build past performance that allows us to Purdue pursue other programs of a similar nature.
Before turning it over to Sean I would like to also comment on the share repurchase program that we announced earlier this afternoon.
As we've said before our priorities for capital allocation are first organic investment in our business.
The addition of synergistic capabilities via acquisition and third with the return of capital to our shareholders.
Our consistent cash flow generation and the strength of our balance sheet allow us to pursue all three and this share repurchase program as part of our plan for driving long term shareholder value.
With that I'd like to turn it over to our CFO, Sean Gillen to discuss the quarter in more detail.
Thanks, John our sales in the quarter or $436 6 million were up eight 2% or $33 million year over year.
Sales in our aviation services segment were up eight 9% driven by recovery in our commercial markets and sales in our Expeditionary services segment were down $1 3 million.
Our commercial sales were up 33%, while our government sales were down 15.
The decline in government sales was driven primarily by the level of activity on our program for the modification and sale of two C 40 aircraft to the U S Marine Corps in the year ago quarter.
Sequentially, our commercial sales declined three 6% due primarily to the impact of the Delta variant on our part supply activities and.
And our government sales declined four 7% driven by the wind down of certain programs and the reduction of activity in Afghanistan.
Gross profit margin in the quarter was 18% or 17, 2% in the prior year quarter and adjusted gross profit margin was 16, 7% versus 13, 9% in the prior year quarter.
This significant margin expansion was driven by the efficiency improvement and portfolio refinement actions that we've taken and also reflects the benefit of closing out certain contracts in our commercial and government businesses.
Gross profit margin in our commercial businesses was 17, 3% and gross profit margin in our government businesses was 18, 9%.
The adjustments in the quarter apply to both the commercial and government end markets, where we're more heavily weighted towards commercial.
SG&A expenses in the quarter were $47 1 million or 10, 8% of sales.
Excluding adjustments of $1 1 million related to severance and investigation and remediation costs. This would have been closer to 10, 6% of sales in line with Q1, despite the decline in sales.
SG&A is still approximately $10 million below the pre COVID-19 amount from Q2 of FY 'twenty.
Going forward, we do not expect SG&A to grow in proportion to revenue as a result of the commercial demand environment recovers and we continue to win additional government business, we expect to be able to drive SG&A to 10% of sales or lower.
Net interest expense for the quarter was <unk> 4 million compared to $1 3 million last year, driven by lower borrowings average diluted share count for the quarter was $35 6 million versus $35 million for the prior year quarter.
As John indicated we generated cash flow from our operating activities from continuing operations of $15 9 million and also reduced our accounts receivable financing program by $10 million in the quarter.
During the quarter, we repaid our Canadian term loan of $24 7 million using our revolving credit facility, which further simplifies our debt capital structure.
Our balance sheet remains exceptionally strong with net debt of $61 8 million and net leverage of four times.
Regarding the share repurchase program as indicated in our release earlier this afternoon.
$150 million authorization to acquire shares at management's discretion during open trading windows, and we intend to fully deploy the authorized amount over approximately the next two years.
You for your attention and I will now turn the call back over to John.
Great. Thank you Shawn.
Turning to the quarter ahead as of now the Omicron variant has not impacted our customers' maintenance planned as such we expect MRO activities to remain at the current levels, which are near full capacity.
<unk> supply, which is our most international activity is more likely to be impacted by the reinstatement of global travel restrictions, which could further extend the timeline for full recovery.
We expect the impact of each new variant to diminish as we move forward, although and although the timing is difficult to predict parts demand. We expect will eventually return.
As operators move to restock their inventory.
Further we expect to grow our business beyond just the scope of the recovery given the incremental interest in U S M and as we continue to secure new long term exclusive distribution agreements.
On the government side. The F 16 program win demonstrates our commercial best practices are resonating with the government customer.
And our pipeline is full and we expect to be able to continue to expand our government programs portfolio.
Notwithstanding the uncertainty we feel good about our backlog and parts supply the loading in our hangers and our government pipeline as such we expect to see sequential growth in Q3 with sales approaching the levels. We saw in Q1.
We are now entering our eighth quarter in a COVID-19 world. We are very pleased with the performance that we've been able to deliver over that time, particularly our margin improvement and our ability to strengthen our balance sheet through consistent cash flow generation, our launch of $150 million share repurchase program reflects our progress and our confidence in <unk>.
We expect continued execution from us over the coming quarters and years and with that I'll turn it over to the operator for questions.
Thank you at this time I would like to remind everyone in order to ask a question. Please press Star then the number one.
Keep beds.
Your first question comes from by the gap.
RBC Your line is now open.
Hey, good afternoon, John and Sean did a nice quarter.
Thank you Ken good to hear from you.
John Yes. Thanks, I just wanted to start off the 33% growth in the commercial business can you. It sounds like from your commentary the parts supply was was maybe down sequentially or maybe not the big driver of that growth can you parse out the growth in the quarter from MRO relative to maybe the parts distribution and and.
Apart trading sides of the business.
Yes, it was.
It was actually spread.
Fairly.
Even though we saw as we mentioned at the end of Q4 and at the beginning of Q1, a real uptick in activity in.
In parts in General and then after Delta took hold we saw that come down a little bit.
But you know it was relatively stable throughout this quarter.
Which was up slightly from the.
From the prior quarter across both the distribution and.
And.
Trading and MRO was.
It does.
The relatively stable.
But and so most of the growth actually come from the parts businesses.
Okay, and obviously, we keep getting these do variance and things seem to be pushing to the right in terms of the recovery.
What are what's your thinking now as to when we might see a more meaningful inflection in either distribution or I guess more specifically parts trading and what are some of the indicators that you're tracking that are going to give you confidence we'll give you better visibility on when we expect that inflection to occur.
Well I think you've gone through a large.
It's a great question I think you've gone through in large part the destocking around the around the world and.
Parts demand for narrow body aircraft, particularly here in North America has recovered the areas that we're waiting to see recover or the international markets and again parts as our most international business. So once we have clarity on consistent borders being opened and travel restrictions being lifted.
That's when we would we would expect to see more continued in a more consistent demand in the parts business and.
Unfortunately, the timing of that is obviously very difficult to predict but related to that.
As you've seen.
The destocking largely complete.
And you've.
You've seen a preference in the U S to U S M material.
We believe that once you get more consistent demand as markets fully reopen there's going to be quite a run unused material because shelves are empty and.
Airlines will have more confidence and inconsistent flying so it's difficult to predict when that's going to occur, but we do expect when it does it'll be a pretty meaningful uptick.
And just one final question on that as you think about the cycle, maybe not just the next few quarters, but the next couple of years, how much do you model, where how much do you assume U S and you assume demand could outpace broader sort of aftermarket parts demand.
I wouldn't want to get into specifics on that but we have seen both from a market standpoint.
I would say international markets, such as Asia as well as just legacy carriers here in North America, a significant increase in interest and use them and so again, it's difficult to predict the path and pace of that growth.
Growth, but but we know that it's there.
Great well, thank you very much and happy holidays. Thank.
Thanks, Ken you too.
Thank you and again, if you would like to ask a question. Please press star one on your telephone Keypad. Your next question comes from the line of Mike <unk> from <unk> Suisse Company Securities.
Your line is now open.
Hey, good evening guys. Thanks for taking the questions.
John maybe just on on the Omicron variant I mean, I guess as we look back at Delta and more more specifically the response, maybe seemed a bit mild versus what we're seeing here now with travel restrictions and everything else going on.
How do we you said, we'll see some growth sequentially back to in line with the fiscal first quarter. I mean, how do you guys think about that in response to what you saw with Delta you know and what we might see here.
On a go forward basis with withheld macrame.
Yeah. Great question, you know the comments about sequential growth are based largely on as I mentioned, we did have some sales slip.
From Q2, and now that it will occur in Q3.
And so we're just looking at our backlog across the company, which gives us confidence that youre going to see sequential growth.
There's no question I mean, you you said it.
Response to <unk> definitely was more rapid and more broad than what you saw with Delta.
But we tend to agree with what other airlines have said publicly is that.
The impact of these each new variant will be shorter.
As a society and as industry and as governments.
We're able to respond more quickly and then hopefully relax restrictions more quickly.
It was the first example of that obviously, we're seeing something you haven't seen the next generation here with overcrowding, but.
Sure.
We're hopeful that each one of these cycles.
Cycles, if you always why these waves the duration will be shorter than the prior.
But the comment specifically related to quarter over quarter growth.
Our are tied to what we see right now in current backlog.
Got it and what was the amount of revenue that slipped out of the current quarter.
If you if you.
If you go back to the guidance. We previously provided we we.
Said that we would be between this quarter that we would be somewhere between Q4 and Q1.
Obviously, we're on the lower end of that had that had those products shipped as planned we would've been right in the middle of that guidance.
Okay got it got it and then just one more maybe.
You kind of mentioned international travel recovering as we think about your parts business. Your distribution business is there a meaningful difference there in terms of narrow body wide body exposure.
We need to see the wide body utilization.
Maybe not come all the way back, but see some overall improvement is that going to be a big driver of some of that parts business for you.
Some it'll be some most of our wide body exposure in the parts business and I should say that we have more wide body exposure in the trading business than we do in the distribution business and most of the wide body exposure in the trading business as its cargo related there is some commercial but that's less of an impact what we're more interested.
The thing is more sustained narrow body travel around the world that would fuel the few the full.
Of the <unk>.
Both the parts trading business as well as the parts distribution business.
Got it got it helpful Alright, great guys I'll jump back in the queue here great. Thank you Mike.
Thank you and our next question comes from the line of Ken Herbert.
From RBC. Your line is now open.
Yeah, Hey, John just to follow up on the F 16 contract you announced how much does that ramp and how quickly and what's the sort of the fiscal 'twenty two incremental contribution.
Yeah, Great question, I would view that as a as an FY 'twenty three contributor the ramp up time for the contract is actually relatively compressed as these things go.
There is the potential that the contract is a protest if it were to go through that process that hasnt happened yet.
Or.
We don't have full visibility to that but once that's cleared.
We would expect a fairly short ramp but at this point, we wouldn't expect any meaningful revenue contribution until until FY 'twenty three.
Okay helpful and on the buyback authorization.
I mean do you still.
Identify.
Organic growth and M&A is higher priorities for uses of capital.
You know M&A hasn't been much of a part of the mix for quite a while and I can appreciate maybe investment opportunities now organically.
Maybe starting to increase but but may be limited as well how quickly do you expect to ramp on the buyback on the authorization and how much.
Usage, there should we expect or are there really some nice opportunities in terms of other investments we should be thinking about.
Yeah, Great question, and we as we mentioned.
The capital allocation priorities are first organic investment second inorganic investment and third returning capital to shareholders and given where the net leverages of the company right now and the opportunity set that we see.
We believe that we're in a position to execute on all three and so there are a number of organic investment opportunities whether it's in the trading business was a distribution business that we're looking at right now M&A.
M&A is something that does remain a focus of ours and on the commercial side, it's been a tricky environment too.
To pursue deals but it is it does remain a part of our growth M&A does remain a part of our growth strategy as it relates to the timing of this I mean, we fully intend to.
Fully authorized already utilize this.
<unk>.
And at the pace.
As Sean mentioned, we are going to commence this quarter.
And then depending on market conditions as well as hell opportunities unfold in the next few quarters.
Will determine the ultimate pace of the employment deployment, but you know at this point.
We chose that about because it fits relative to the other opportunities that we see and it's something that we think we can get done in a reasonable period of time.
Okay, that's great and if I could just one final clarification I just wanted to confirm you indicated that as a result of omicron you havent seen any change to your MRO schedules or or backlogs I just want to make sure I got that correctly.
It is correct that is correct.
Okay, Great alright, thank you.
Alright, thanks, guys.
And again, we have a question coming from the lag Mitel sure Mani <unk>.
Security centralized Alabama.
Hey, guys. Thanks for taking the follow up John just as we think about labor.
In a tight labor market. How are you guys feeling I mean, what we're going to get through the holidays here pretty quickly and then youre going to probably get into that busy kind of prep, yes summer repair season, I mean, it seems like maybe I'm, an optimist that airlines globally would probably be looking even more aggressively to a hopefully close to <unk>.
Its normal 22 flying season, do you feel comfortable with.
Labor as you move into these potentially busy quarters.
Yes, again, a great question.
Labor dynamic, it's something that we're paying an awful lot of attention to and the short answer to your question is it's really tight.
But because of the initiatives that we but if it gets really tight.
I'd say it is definitely tighter than it was pre COVID-19.
And I would characterize that as we're seeing pressure.
Not just at the lower levels.
It was not just with the.
Mechanic hourly labor, but.
But we're up and down throughout the organization.
So it's a bit of a broader base in terms of tightness, but because of the initiatives that we announced pre COVID-19.
Covid.
I think we're in a pretty good position. The other thing I would say is that.
Customers have worked.
Very closely with us to keep the hangers and the loading in the Hague was relatively consistent so.
What we used to experience with major gifts during the summer and.
Significant dip during the holiday season.
Which resulted in up and down moves in the overall labor force the customers who've worked with us to level load us through those periods, which has allowed us to keep the labor force up together and so it's a long question, but sitting here today, we are.
We feel good about the schedule that we have in our ability to meet the schedule and.
But it is a daily daily focus of ours.
Got it very helpful. Thanks, guys.
There are no further questions at this time I would now like to turn the call back to John.
Well. Thank you very much everybody, we really appreciate the time and the interest and we wish everyone a safe and happy holiday season. Thank you.
This concludes today's conference call you may now disconnect. Thank you.
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