Q3 2022 AAR Corp Earnings Call
Okay.
Good afternoon, ladies and gentlemen, and welcome to Aar's fiscal 2000, <unk> third 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 1995 East.
These 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.
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 , the fiscal quarter ended November 32021.
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 to the most comparable GAAP measures is set forth in the company's earnings release at.
At this time I would like to turn the call over to <unk>, President and CEO John Holmes.
Great. Thank you and good afternoon, everyone. I appreciate you joining us today to discuss our third quarter fiscal year 2022 results.
I want to start by saying that our thoughts are with those impacted by the conflict in Ukraine whereabouts saddened and angered by Russia is unprovoked invasion and stand with all those who are suffering although we do very little work in either country. We have suspended all of our business with the sanction nations and territories.
That said and turning to the quarter, our sales increased 10% year over year from $410 million to $452 million and our adjusted diluted earnings per share from continuing operations increased 70% from 37 per share to <unk> 63 per share sequentially overall sales grew three 6%.
In our commercial business, we had another strong quarter in MRO or parts activity started out slowly in the quarter gained momentum as the impact of the <unk> variant decline.
As we've discussed previously parts supply is our highest margin activity and its recovery is paced behind MRO.
The parts momentum during the quarter gives us continued confidence in the eventual full recovery and ultimately more growth out of that activity on the government side, we were able to drive sequential growth. Despite the headwinds we face as a result of the Afghanistan withdrawal.
Regarding earnings I'm, particularly pleased that we delivered another quarter of margin expansion as our adjusted operating margin was six 7% sequentially. This is up from six 1% in the second quarter and continues to exceed pre COVID-19 levels. Despite our commercial sales remaining down more than 25%.
Turning to cash we had another excellent quarter as we generated $16 million of cash.
From operating activities from continuing operations.
We also repurchased $20 million of stock consistent with the share repurchase program, we announced earlier in the quarter.
Even after the share repurchases our balance sheet remains strong at 0.4 times net leverage and we continue to be exceptionally well positioned to fund our growth.
Regarding new business during the quarter, we announced a 10 year renewal of our component MRO contract to provide depot level maintenance for Nato's E <unk> aircraft.
Subsequent to the end of the quarter, we announced a new exclusive distribution agreement with Collins aerospace to supply <unk> and supporting products to the global aftermarket.
This is an important win because it's our first exclusive commercial distribution agreement with Collins and it also represents a move into the business jet market, where we see adjacent opportunities for growth. This most recent distribution win demonstrates both the value proposition that our offering brings to component Oems and our ability to continue to drive market share gains in this active.
<unk>.
With that I'll turn it over to our CFO , Sean Gillen to discuss the quarter in more detail.
Thanks, John our sales in the quarter or $452 $2 million were up 10, 2% or $41 $9 million year over year.
Sales in our aviation services segment were up 12, 4% driven by recovery in our commercial markets and sales in our Expeditionary services segment were down $6 4 million driven by a delayed pallet order that we expect to now receive in Q4.
Our commercial sales were up 28% year over year, while our government sales were down 8%.
The decline in government sales was primarily driven by the wind down of our activity in Afghanistan and the natural completion of other government programs.
Our sales in Afghanistan in the quarter were $8 million and we currently expect to be down to approximately $1 million in the fourth quarter.
Sequentially, our commercial sales increased two 8% and our government sales increased four 6%.
Our MRO operations remains near capacity and although we saw increasing parts volumes throughout the quarter overall parts growth was limited by the slower start that John referenced.
On the government side, the sequential sales growth was driven by our ability to secure additional work in our government programs operations, which was more than sufficient to offset the reduction of activity in Afghanistan.
Gross profit margin in the quarter was 17, 8% versus.
Versus 21% in the prior year quarter, which included the benefit of cares Act payroll support <unk>.
Adjusted gross profit margin was 17, 3% up from 16, 1% in the prior year quarter and 16, 7% in Q2.
This margin expansion continues to be driven by the efficiency improvement and portfolio refinement actions that we took during the pandemic as well as improved conditions in our commercial parts activities.
Gross profit margin in our commercial business was 21% and gross profit margin in our government business was 14, 5%.
In the quarter Commercial's margin benefited from intercompany procurement activity on behalf of government customers.
SG&A expenses in the quarter were $48 9 million or 10, 8% of sales excluding adjustments of $1 7 million related primarily to investigation and remediation costs. This would have been closer to 10, 4% of sales.
Net interest expense for the quarter was <unk> 6 million compared to $1 million last year, driven by lower borrowings.
Average diluted share count for the quarter was $35 7 million. This reflects the repurchase of <unk> 5 million shares during the quarter. We expect to continue to execute on our previously commuted plan to deploy the full $150 million authorization over approximately two years.
As John indicated we generated cash flow from our operating activities from continuing operations of $16 2 million and we also reduced our accounts receivable financing program by $2 2 million in the quarter.
This strong cash flow largely funded the 20 million share repurchase in the quarter and our balance sheet remains exceptionally strong with net debt of $63 9 million and net leverage of <unk> four times.
Thank you for your attention and I will now turn the call back over to John .
Great. Thank you Shawn.
Regarding the environment as I indicated earlier, we do not have meaningful sales in either Russia, or Ukraine, and so we're not currently experiencing any notable business impact as a result of that conflict. However, we are certainly aware of the related increase in fuel prices and are monitoring the potential impact to our airline customers operating costs.
Domestically, we are continuing to observe tightness in the labor market and our attrition levels, particularly in the hangars have been higher than they were before the pandemic. However, we are fortunate that we took aggressive action beginning in 2019 to address our labor supply. When we had started to experience labor shortage shortages at that time.
To date those actions have allowed us to manage through the current environment more effectively than much of our competition and our customers continue to be supportive of moves that we need to make to navigate this tight labor market.
With respect to commercial demand, our largest north American and European commercial customers remain optimistic about the recovery of demand in the business and leisure travel market and we saw this translate into accelerating parts volume throughout the quarter.
This increasing demand is encouraging and as a result, we expect to see continued recovery in our parts activities over the next several quarters in the immediate term, we expect modest sales growth sequentially in Q4, and a more meaningful inflection in our FY 'twenty three having said that we recognize that we remain in a dynamic environment and new <unk>.
Elements with respect to Covid may continue to impact this trajectory rigs.
Regarding margins this quarter is a good representation of the full impact of the margin improvement actions. We took during the pandemic and the potential for further expansion will depend on the mix and pace of the recovery.
Early in the pandemic, we took a series of actions to drive operating efficiency and balance sheet strength with a goal towards achieving higher margins, even without a full recovery in sales I am extremely proud that we have delivered on that plan. We have now expanded operating margins for six straight quarters, and we were one of the very few companies in <unk>.
<unk> aerospace with a stronger balance sheet than we had prior to the pandemic. Our performance has positioned us to invest in our business, both organically and Inorganically and continue to deliver value for our customers shareholders and other stakeholders with that I will turn it over to the operator for questions.
And as a reminder, if you would like to ask a question you will need to press star one on your telephone keypad.
And if you would like to withdraw your question press the pound key.
Your first question comes from the line of Ken Herbert from CBC. Your line is open.
Hey, good afternoon, John and Sean.
Hey, Ken.
John I just wanted to start off the up 28 in aviation in the quarter can you just talk about the relative performance of MRO relative to the parts businesses.
Sure both of those were actually consistent with what we saw in Q3. So in the parts business as we indicated we got off to a slower start we saw volumes a bit down early in the quarter, which we assume was.
Related to pullback from the Omicron variant as a result of the <unk> and then throughout the quarter as the.
The impact of that variant subsided, we saw accelerating parts volumes that ultimately and that's continued through today ultimately were higher than what we saw in Q2, but net net parts was about even quarter over quarter.
The MRO business was consistent from Q2 to Q3 again the hangars there remain largely full and we're really happy with the performance there.
The growth, though quarter over quarter sequentially.
Sequentially. It came from other areas of the commercial business, we saw a recovery in our commercial programs business. So our customers in that area started to fly more hours, which translated to more revenue given the nature of the PVH programs and then we saw another strong performance in.
Other areas of the MRO business out of component repair as well as our landing gear operation.
Okay, that's helpful and if I could on the.
On the aerospace side can you just dig a little bit deeper into the potential risk to the business and the recovery from from higher higher.
Higher crude prices or fuel prices for your airline customers I know on the one hand, it would obviously support.
Usage of newer assets, which might create more U S. M feedstock, but obviously on the other hand, there is clearly just a risk to sort of their balance sheets and the operating models. So can you talk through your expectations of how that could impact your business over the next few quarters.
Yes, sure and I think you highlighted you've got a few different competing dynamics. There certainly it's a situation we're monitoring monitoring and it's a situation that AAR has seen many time over the decades that we've been.
In the industry I.
I would say that this is.
Pretty meaningful a function of how much of the fuel price increases the airlines are ultimately able to pass on to the ultimate path.
Passed onto the consumer.
We've talked to lots of our customers and there's varying views on how much of that will be able to be to be passed on.
That's a factor that ultimately.
<unk>, how they think about their expenses, but we are as we think about the customers operating costs and to the extent that they see sustained increases it's going to it's going to drive them to lower cost solutions and we are.
Or a lower cost solution.
Okay. That's helpful and just finally, if I could maybe for Sean I mean, the balance sheet. You could argue is significantly underutilized now as we continue to see some recovery on the commercial side. How are you thinking about capital allocation and are there opportunities or do you feel like you should maybe put a little bit more onto the balance sheet as you think about accelerating.
Growth in any areas.
Yes, good question and I think the capital allocation priorities remain the same we do see increasing opportunity to invest organically and specifically in the parts business. So inventory has been providing cash over the past several quarters and I think there we're seeing opportunity on new business wins in distribution as well as procurement.
Activity in used serviceable material to invest in that.
There continues to be inorganic opportunity via acquisition.
So that will be we think that could be an area for us to allocate capital and then the repurchase we did $20 million in the quarter. So got a good start to the new repurchase and we'll continue to look to put money to work there, but I think that the balance sheet. As you say is arguably under levered, but we do think we have adequate and full opportunity to put money to work.
Great Alright, well, thank you very much.
Thank you Ken.
Once again, if you would like to ask a question. Please press star one on your telephone keypad.
Our next question comes from the line of my question from Sheila Your line is open.
Hey, good evening guys. Thanks for taking my questions and nice results.
Maybe John just to go back to Ken's line of questioning on fuel I mean can you specifically.
Indicate or tell us are you seeing any behavioral changes from your customers at this point yet in terms of whether it's <unk>.
Spending on discretionary upgrades or where are they planning on.
Doing maintenance.
It's our heavy visits.
Older planes that they are now thinking with this current fuel environment it might be better to retire those plants or are you seeing any of that yet or having discussions with them around that.
Great question and the answer is really no it <unk>.
Certainly top of mind for everybody, but the overriding conversation with our customer base right now and again I'm focusing on North America and in Europe is really around being prepared for what our airline customers see as a very strong spring and summer.
And the <unk>.
Other thing we are getting is that.
There seems to be I guess, a happy surprise around the pace of business travel return and so the airlines right now we're just focused on making sure that they've got enough equipment available and ready to support what they see as a very strong a couple of quarters.
After that Scott.
So the headlines okay.
Got it.
Good segue too because I wanted to I mean.
Fiscal fourth quarter is usually seasonally your strongest I think in.
Some of your prepared comments you kind of said you expect I think you were just talking about parts continuing to recover with modest growth in the fourth quarter, but what about <unk>.
The entire business should we expect that that pretty steep.
Sequential increase <unk> to <unk>, and then and then even if you can maybe give us some directional color on how to how to think about next year and this sort of.
Uneven time with Colgate do we expect that normal pullback in the fiscal first quarter or just given kind of the.
And do you think revenue growth keeps building sequentially.
Yes, I think again good question.
The comment related to overall modest improvement from Q3 to Q4 that was that was meant to be overall sales modest increase from okay in Q.
And you've got a few different parts in there you've got.
MRO, which we expect to have another.
Strong quarter in MRO.
And then you have continued momentum in the parts business.
But also we haven't talked a lot about government yet, but our government this will be a another quarter of.
<unk>.
Feeling the full impact of the withdrawal from Afghanistan as well as the other natural complete completion of some of the other.
Programs and so theres a lot of work that we need to do on the government side to make up for that while we are.
Let's say waiting but focused on other longer term government programs like the <unk> safety contract kicking in that will ultimately replace the lost revenue if Afghanistan. So again, we're thinking about stronger performance out of commercial but government has a bit of a.
Bit of a mix at the moment, while we're in transition between the wind down from Afghanistan, and the ramp up of other long term programs.
<unk>.
And then thinking about next year I think we mentioned that we're expecting modest improvement overall from Q3 to Q4, but a more meaningful inflection in the results as we get into our next fiscal year and hopefully covenants further and further in the rearview rearview mirror and as it relates to the first quarter.
As it relates to the first quarter, specifically the biggest seasonal driver there is typically our MRO business and at this point we expect.
And again all of this.
Subject to a dynamic environment, but at this point, we expect another strong summer as airlines continue to get aircraft ready to support the recovery in demand.
Okay. Okay got it just.
Just a quick one on government are there given what's going on with.
With Russia, and Ukraine are there any opportunities for you guys.
<unk> contract covers a lot of those.
Eastern European countries.
Are you seeing indications that you.
You could see a scope increase there or increased revenues as a result of I'll call. It increased op tempo over there.
Yes, I would say again another good question I'd say, there's really three areas that Ukraine could that that situation could could provide positive tailwind for us. One is we saw a pretty meaningful decline in our day to day parts business with the DLA as the.
A new as the buying administration shifted priorities from spending on sustaining shifted priorities from sustaining the current fleet to directing dollars towards the next generation development, obviously, given where we are in the world right now having the current fleet in a better position to be ready to go it would seem.
That would be a priority and so you could see.
More sustainment dollars being spent which would translate into broad parts demand for for US we haven't seen that yet, but it's something we could anticipate.
The other area is in our mobility business you could see to the extent that there's going to be.
Groups moving around the world you could see elevated demand for the shelters and containers that we manufacture.
We again, we haven't seen haven't seen that yet, but if we look over the decades, what typically followed situations like this.
We would expect to see some activity there depending on how this unfolds.
The final thing.
The third area that you've touched on his watch.
That is a program that.
A big part of it is flying diplomatic missions historically you've seen.
Democratic administration, such as the one we're in utilize diplomacy more and so you may see increased tempo out of that program as a result of the increased diplomatic activity.
And that's another area, where we could see positive benefit over time again, it's still very early we haven't seen any meaningful movement in any of these areas, but those are the three key areas I think that could be impacted by a sustained prolonged conflict.
Got it very helpful I'll jump back in the queue guys.
Okay.
Once again, if you would like to ask a question. Please press star and then the number one on your telephone keypad.
Okay.
Last question from Michael Sure Mani from Julien Your line is open.
But nobody else jumping on and figured I'd get back out here.
Two other follow ups John .
You mentioned the tight labor market any color about wages and passing those along to your customers and maybe thoughts on how that could impact margins do you mean, you sounded pretty confident in the operating margin story is that is that something that could create some headwinds.
Yes, I think again a good question a.
A couple of thoughts there, yes to date, we've had very constructive dialogue with our customers, where we need to.
Around potential adjustments to contracts.
To support increases in labor, it's definitely a tight market as I mentioned I think we're managing that very well.
But it's still very dynamic and it's something we're paying a lot of attention to and it varies by market.
You might see tightness in one market and therefore, we need to talk about raising wages in one area more than another depending on how recruiting is going and that in turn drives decisions or conversations with the customers, but so far they have been.
They've been supportive.
If we think about that as it relates to margin.
Yes, as labor cost increase and to the extent, we cannot pass them fully on to the customer we could see some margin headwind in the MRO business, but on the flip side, our parts businesses, which are higher margin MRO has not fully recovered were still down $20 to 25% there and us.
We said given the anticipated.
Recovery in the overall industry, we expect those businesses the parts businesses, the higher margin businesses to get back to where they were pre pandemic and ultimately exceed pre pandemic levels, particularly in our new parts distribution business because we've signed.
We just mentioned the call of the agreement.
We've signed a number of new distribution agreements over the past.
Two years and those are not yet fully reflected in the results from our base of business and commercial parts distribution ultimately will lead to <unk>.
Growth as we fully recover so again, you've got to you've got some competing dynamics there between potential headwinds with labor costs, but then.
A potential tailwind with.
With the growth and recovery in the parts business, which is higher margin.
Got it and then last one I had which another good segue you mentioned.
<unk> created or caused you to finally break through with Collins.
Thank you said that was your first win on the distribution side.
Was there anything that kind of kind of puts you over the edge there or anything you can point to.
We.
Thanks for asking that we have had a coordinated effort with Collins and other large Oems for some time now and the value proposition that we represent in the market as the largest independent distributor and I stay independent because we're not part of an OEM like Boeing or Airbus, that's gaining some traction and as you've seen we've got we've had a step.
Eddie Drumbeat.
<unk> four wins over the last.
The last several years and that's starting to get noticed and the other thing I would say is that.
Our sales force our team.
Really focuses on becoming technically proficient in our OEM partners parts.
And our goal is to go out there and help the Oems that we partner with on exclusive basis displace competitive products. So we're not a call center, we're not just holding inventory waiting for a call. We're out there as a true extension of our partners and we think that's a unique model in the industry and again, it's getting some traction with the larger players like Colin.
Got it helpful. Alright, thanks, guys.
Thanks, Mike.
And we have another follow up question from the line of Ken Herbert from RBC. Your line is open.
Hey, John just a quick question it sounds like the commentary youre pretty comp pretty confident and optimistic about a positive inflection in 'twenty three aerospace sales. If I heard you correctly is that correlated with with maybe an inflection you're expecting to see on the part side and surplus material.
Particular, we can you can you provide any more sort of commentary as to what's behind that that expected step up in 'twenty three.
Yeah and again.
So yes, it is largely driven by our expect our expectation around parts.
We've been encouraged by the recovery in demand that we've seen of late provided that.
We don't get some other curve ball thrown at us as an industry by Covid, we think that trend is going to continue and going back to what I said earlier, given the fact that the parts businesses are still $20 to 25% down Theres room to run there just out of recovery and then given the fact that we've won.
New lines like Collins in distribution.
Those lines mature and older lines recover.
Got built in growth there based on the business, we signed up so.
We feel good I would expect that.
So that's where we would look for the growth to come from and then I would just go back to on the MRO side.
The hangers are full we're performing well.
And.
We're in a good spot there.
But.
I was expecting a relatively favorable performance out of MRO on the commercial side.
Given given where we are at capacity.
Okay, and then given the mix shift it sounds like in 'twenty, three potentially with greater growth on the parts side relative to MRO, how should we think about incremental margins. It sounds clearly like your.
Sort of a cost story near term has run its course, and we need to see volume to really drive margins, but what kind of incrementals should we should we think about for models as you see that and mixed benefit in 'twenty three.
Yes, I think I think we need to see how that plays out we feel good about the full impact we feel really good about the progress that we've made to be in a position ahead of pre pandemic margins.
While sales have not recovered we're very proud of the progress that we've made there.
Going forward I think we need to see how the competing dynamics in terms of the pace of the parts recovery combined with how we address potential labor cost headwinds, we need to see how those dynamics play out, but I would say that.
We're very proud of the progress that we've made and as that unfolds and as the mix plays out over time expect to continue to expand our margins, but it's difficult to get more specific than that right now.
Okay.
Fair enough. Thanks, a lot.
Right.
Once again, if you would like to ask a question. Please press star and then the number one on your telephone keypad.
Okay.
Okay, well, we really appreciate the time and the interest in <unk>.
We look forward to being back with you all in July to discuss the full fiscal year results.
And this concludes today's conference call. Thank you for participating you may now disconnect.
Okay.
Okay.
[music] industry.
Okay.
[music].
Yes.
[music].
Okay.
[music].
Yes.
Yes.
<unk>.