Q2 2024 AAR Corp Earnings Call
Yeah.
Good afternoon, everyone welcome to our fiscal 2024 second quarter earnings call. We're joined today by John <unk>, Chairman, President and Chief Executive Officer, Sean Gillen, Chief Financial Officer.
Before we begin I'd like to remind you that comments made during the call may include forward looking statements as defined in the private Securities Litigation Reform Act of 95 esports looking statements involve risks and uncertainties that could cause actual results to differ materially from the forward looking statements.
These statements are no guarantee of future performance. These risks and uncertainties are discussed in the company's earnings release and the risk factors section of the company's annual report on Form 10-K for the fiscal year ended May 31, 2023, and Form 10-Q for the fiscal quarter ended August 30 123.
In providing the 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, Chairman, President and CEO John Holmes.
Great. Thank you and good afternoon, everyone. I appreciate you joining us today to discuss our second quarter fiscal year 2024 results.
We discussed these results I wanted to comment on the acquisition agreement that we announced this morning for many years, we have been focused on growing our position in the market for our proprietary and differentiated services and we have long viewed triumphs product support group as one of the leaders in this market for repair.
In fact, the more than five years since I became CEO I've had a number of conversations with triumph CEO about the possibility of AAR acquiring this business. So similar to our Trax acquisition that we announced earlier. This year. This is an idea that we have had for a long time and I'm very excited that we have reached an agreement with triad.
We will be we believe this acquisition will bring scale to our existing component repair operation at next generation repair capability, deepen and broaden our customer relationships globally and expand our footprint.
The quality of this business as reflected in its margins, which we anticipate will meaningfully enhance our own margin profile.
In fact, numerous benefits associated with integrating our existing parts supply repair and engineering and integrated solutions volumes with this businesses operations.
Try and product support also comes with a large DDR portfolio and significant PMA development capabilities. We expect this will accelerate our growth in each of these areas.
Additionally, it's Thailand facility will help AAR.
Further penetrate the high growth Asian market.
Finally, this business comes with a talented and accomplished leadership team.
Overall, we expect this acquisition, which fits squarely into our stated strategy to be highly value accretive and it adds significant scale differentiated capability operating margins of approximately 18% our strong cash flow profile and significant synergy opportunities.
Turning to the results we delivered another strong quarter of financial and operational performance, which resulted in record adjusted second quarter earnings.
Pacifically sales for the quarter up 16% year over year from $470 million to $545 million.
Sales to commercial customers increased 24% and sales to government customers increased 1%.
Within parts supply sales were up 24% over the prior year quarter, driven by strong customer demand for used serviceable material and continued expansion of our commercial distribution activities.
Regarding <unk>, our global sourcing team continues to secure material that is in high demand.
Much of this material requires repair work before it is resolved and we continue to navigate extended turn times with our partner repair vendors.
New parts distribution saw continued growth in both our existing and new commercial product lines, which more than offset continued slower parts sales to the U S government.
On that note, we have started to see a slight increase in our parts booking with the government which is encouraging.
And repair and engineering sales were up 8% over the prior year quarter, driven by strong performance across our hangers and component repair operations.
And integrated solutions sales were up 23% over the prior year quarter due to increased flight hours in our power by the hour programs and strong performance across our government programs. Trax also contributed to sales growth this quarter and that integration continues to go well.
On that note Trax as a growing pipeline of opportunities as the value proposition of combining <unk> industry, leading software with AAR scale and financial support is resonating with customers across the book.
Expeditionary services sales were down 34% over the prior year quarter due to a significant decline in mobility shipments of pallets to the department of defense.
As a reminder, mobility products are used in support of U S troops overnight, which does not increase in the current environment. The decline in sales activity as a result of funding being diverted to the effort in Ukraine, and we expect this to return to a more normalized levels towards the end of our fiscal year.
Turning to profitability, our adjusted operating margin was eight 1% up from seven 6% in the prior year quarter operating margins expanded in parts supply and repair and engineering Trax also contributed to our overall margin expansion. Further this represents our 11th straight quarter of year over year adjusted adjusted operating.
As an improvement.
Our operating or adjusted diluted earnings per share from continuing operations were up 17% from 69 cents per share.
Second quarter last year to a record of 81 per share this year.
With respect to cash we generated $17 million in cash flow provided by operating activities from continuing operations in the quarter.
We continue to see attractive opportunities to invest in our parts supply segment, which resulted in net inventory increasing $32 million during the quarter we.
We expect these investments to continue to drive growth for both U S M and distributions.
Our cash flow and continued EBITDA growth resulted in leverage at the quarter end AUM of only 1.0 times adjusted EBITDA and as such our balance sheet remains exceptionally strong which helped enable the agreement to acquire <unk> product support business.
Turning to new business, we had several wins announced during the quarter and subsequent to the quarter.
These wins across across multiple business segments inside of AAR and demonstrate the strength of our operating customers and repair and engineering, we announced an extension and expansion of our airframe services agreement with Alaska Airlines, including the planned corresponding expansion of our hangar capacity It will Rogers World Airport in Oklahoma City.
Similar to our previously announced expansion in Miami. This product meets all the criteria that we've outlined for MRO capacity growth, which includes a supportive relationship with the airport local government.
Favorable labor market dynamic and a long term customer commitments.
We are excited about this opportunity and we'd like to thank Alaska Airlines, Oklahoma City Airport Trust and all those who made this possible.
And heart supply, we announced a multi year contract extension with MTO maintenance to supply U S. M parts for Pratt and Whitney 2000 engines, and also we announced a new multi year distribution agreement to supply Woodward's fuel control products to the defense logistics agency under our captains of industry contract.
And integrated solutions, Aeromar announced a new multi year services agreement with Turkish based low cost carrier Pegasus Airlines for warranty support services with that I'll turn it over to our CFO, Sean Gillen to discuss the results in more detail. Thanks.
Thanks, John our sales in the quarter of $545 $4 million were up 16, 1% year over year. Our commercial sales were up 23, 5% driven by growth across most of those operations, particularly part supply and our government sales were up one 4% due primarily to integrated solutions, partially offset by declines for new.
Parts distribution in parts supply and expeditionary.
Gross profit margin in the quarter was 19% up from 18, 3% in the prior year quarter on a reported basis and up from 18, 8% in the prior year quarter on an adjusted basis.
Overall margin performance was strong across our activities with notable improvement in commercial programs as well as the contribution from Trax.
Gross profit margin in our in our commercial business was 24% and gross profit margin in our government business was 15, 4%, which reflects the softer performance in mobility that John mentioned.
SG&A expenses in the quarter were $65 7 million, which included $3 1 million from acquisition and amortization expenses and $2 $6 million of investigation costs.
Excluding these items SG&A was $60 million or 11% of sales.
Net interest expense for the quarter was $5 5 million compared to $1 5 million last year, driven by higher interest rates and borrowings.
Cash flow provided in operating activities from continuing operations was $17 4 million.
In addition to generating cash we continue to invest in the business as evidenced by the $32 million increase in inventories.
Our balance sheet remains exceptionally strong with net leverage at one times, adjusted EBITDA, which enables us to make both organic and inorganic investments, namely our announced acquisition of triumph product support.
On that note with respect to the planned acquisition as indicated in the release and the slides that we posted to our website the consideration is $725 million.
We expect to receive tax benefits with a present value of approximately $80 million as part of the transaction.
Net of this tax benefit the purchase price of $645 million, which represents a multiple of 11 seven times EBITDA for the fiscal year, ending March 2024, and nine nine times EBITDA inclusive of the $10 million of run rate synergies.
Funding for the acquisition is supported by fully committed bridge facility. The closing of the acquisition is subject to regulatory clearance and other customary closing conditions and we plan to conduct a permanent financing in conjunction with the closing that will include debt and subject to market conditions equity.
Inclusive of an equity issuance our target net leverage at closing is approximately three times.
We expect to we expect to begin to realize synergies shortly after closing and to fully realize the run rate synergies by the end of our fiscal year 2026.
Given the growth in cash flow outlook of both the target and AAR, we expect to further Delever post close.
Transaction is expected to be accretive to our adjusted earnings per share for our full year fiscal 2025.
Note that consistent with current practice, our adjusted earnings per share and adjusted operating earnings will not include noncash amortization.
Amortization and similar expense associated with purchase accounting.
We anticipate to be approximately $20 million to $25 million per year.
You for your attention and I will now turn the call back over to Josh.
Great. Thanks, Sean I am pleased that we delivered another strong quarter of year over year revenue growth and adjusted operating margin expansion.
The macro environment for the commercial aviation aftermarket continues to be very strong and our customers have signaled strong demand for our services in calendar 2024.
Furthermore, our continued new aircraft delivery constraints and issues related to newer generation engines are expected to drive increased demand for mid to late life aircraft, which as you know is a core market for AAR.
For our parts activities, we expect continued growth in both U S M and new parts distribution, we expect to invest in both the USA material as well as the new business wins in distribution and expect these investments will drive our results going forward.
And repair and engineering, our hangers are operating at near capacity and we expect that to continue for the foreseeable future. We are excited about the plant expansions at both our Miami and Oklahoma City facilities.
And integrated solutions, our Trax acquisition is performing well and positively contributed to our financial results. Our portfolio of government programs is stable and we believe we have a strong pipeline of opportunities with the department of defense and other government customers as.
As we turned the calendar year 2024, we're focused on converting this pipeline to new business wins.
Looking forward with respect to Q3 overall, we expect continued year over year over year sales and earnings growth, specifically, we expect high single digit to 10% year over year sales growth and adjusted operating margins to be consistent with the quarter that we just delivered this does not assume any impact from the product support acquisition.
Announcements.
Credibly proud of the work our team continues to do to produce the record results that we have achieved the favorable macro environment and our ability to execute continues to be a powerful combination.
Further the acquisition of try and product support meaningfully accelerates our strategy to add differentiated complementary high margin capability to our overall aviation services offering and we could not be more excited to welcome triad product supports talented team to AAR.
That I will turn it over to the operator for questions.
Thank you to ask a question. Please press star one one on your telephone and wait for your name to be announced.
So withdraw your question. Please press star one one again, one moment, while we compile the Q&A roster.
And our first question will come from the line of Robert Spingarn with Melius Research. Your line is open.
Thank you hey, guys congratulations on the deal.
I'd like to ask maybe a multipart question on that and then I have a question on the business but.
Let's start with the topline you mentioned I think that the deal should be accretive to sales growth, but which sales growth target is that next 12 months is that your long term target you talked about in July how do we think about that.
Yes, I think we think it will be accretive to sales growth. After we close the deal and it contributes and I think that 5% to 10% that we've talked about long term I think it's accretive to that as well and we're pushing it higher to push it to the higher end of that range.
Okay, and then I know John I think you talked about synergies I just wanted to and you ran through a bunch, but high level. If you could detail that a little bit on the cost side, and then as well on the revenue side revenue synergies.
Yes, sure the $10 million that we cited at all cost.
And we expect that to come from multiple areas that we feel very very confident in that number now with our two existing repair site in New York and Amsterdam as well as the five sites that we're taking on and with triad.
We've got a.
A fair bit of opportunity to rationalize capability amongst all of those sites and that will drive some.
A good chunk of the cost synergy Odisha.
Additionally, there's actually quite a lot of repair work that we send out in support of our power by the hour programs that could go to trial, but today goes to other vendors and so we would expect to consolidate that work ultimately based on the new capability that we're acquiring those would be the two major building blocks of the cost synergies at this.
We have not in that number of 10 factored into any revenue synergies, but you can expect that.
But we believe that there is quite a lot of opportunity to cross sell amongst your customers, where <unk> is strong and we're not and Conversely customers were strong in time does not.
Is it fair to think of this as a good platform for your parks.
Can insert those into the try and facilities.
Yes, I think yes within outlet there the other synergy between the repair business and the parts business is we have to support the trading business, we have a fairly large rotable pools.
Both of our ratable contractual rotable components, but also structural component.
Those components are synergistic with repair about it repair businesses because they also augment turnaround times.
Provide exchange unit and extraction units and so the.
The trading business and the repair business have synergies that way as well.
Okay, and then last one on this Sean for you.
Thank you about the potential.
Equity issuance versus just debt financing the entire thing it seems like the accretion is pretty similar.
But the equity dilution would be more long term lets say unless you bought back the stock so what's the calculus behind that.
Our balance sheet, so the balance sheet puts us in a good spot and I think the way we think about that is targeting three times at close which would be inclusive of an equity issuance. If you didn't have an equity issuance you'd probably be closer to 3637 and the thought there just continuing to be more conservative on the balance sheet.
<unk> and continue to allow for investments to help drive growth across the other businesses as well.
So evaluating equity alongside the debt.
Got you Okay. John last one it's on the business last time, you talked a little bit about some headwinds having.
Having the end of <unk> are coming from the end of a landing gear overhauls overhaul cycle.
And just wondering do you have any more of those coming up either in the core business or at triumph, where you either have a headwind because overall a certain component cycle is ending or you have a tailwind because we wanted to starting.
Sitting here not that not that I can think of I mean landing gear out of all the repair businesses, both heavy maintenance as well as well as all of the businesses involved in is the most cyclical so that would be that would really be situational to landing gear.
Versus our other MRO operation and certainly the operations in trials portfolio.
Okay. Thanks, so much.
Thanks, Rob.
Thank you.
Our next question.
And that will come from the line of Bert Steuben with Stifel. Your line is open.
Hey, good afternoon.
Appreciate the question.
Hey, thanks for thanks.
Thanks for joining US you picked a good time.
Yes, that's right.
Maybe John just to start with a high level on the <unk> side can you just provide us some context on what this acquisition does for you that you think would have been.
Too difficult to do organically and I guess the reason I'm asking is like how do you think about what this brings to overall AAR and why that sort of speeds up the process of growth.
Yes.
Question.
A few thoughts there first of all I want to highlight that this was a negotiated transaction. This was not a process.
The CEO of triumph and Crowley and I.
Works together on that.
Sure.
That came out of the fact that for several years as I mentioned at the beginning we have felt that this business would be highly complementary and strategic to us.
<unk> offering so.
We are very pleased that the stars align and we were able to.
To reach agreement with try them would.
What it brings to US is the number of a number of things.
As I mentioned there are synergies around.
Just straight cost and that'll come from footprint rationalization across the combined seven facilities as well as in sourcing quite a lot of work that that AAR sends out today in support of our.
Our flight hour programs.
There is also a great deal of capability that try and pass.
That has taken decades to to create and would be near impossible.
Replicate today.
Have an incredible blue chip customer base, many of which have been therefore with them for decades. So those relationships are very very solid and the proprietary repairs that come through their <unk> they've got over 6000, <unk> again, those took years and years to develop as.
As well as the PMA business that is.
It's still relatively small in the scheme of things.
But the years ahead of where we are in PMA really jumpstarts, our PMA efforts there so.
It would have taken a very very long time, and a tremendous amount of capital.
To replicate what they have and the margin accretion here is very significant if you think about our long term growth targets and margin.
<unk> pulled that forward by a couple of years to get AAR close to our ultimate double digit goal of operating margin, 10% and beyond.
Okay got it maybe just a question just a clarification question there on the PMA side is there any sort of granularity you can provide I know you guys had talked about organically doing that what does this do for you and that is it sort of the similar types of parts that you were looking to do organically or is this going to be complementary to what youre thinking about doing organically.
It's complementary to what we think about organically in their PMA efforts are largely focused on interior parts Chris.
It comes out of the legacy interiors business.
And.
They've got a nice portfolio, there and a nice growth plan for the PMA portfolio, but focused on interior parts, which is complementary to where AAR is focused.
Got it Okay, and then on the other side of parts <unk>. It sounds like Youre seeing some some positive indicators there you're trying to keep the balance sheet in pretty good shape, presumably to keep acquiring material.
Obviously Oems have been pricing.
Pretty well over the last few years and so there is likely a good spread you can keep getting there as USF supply comes out you should still get price is that consistent with what youre seeing and sort of what inning. Do you think we are in in terms of the U S M recovery.
That is what we're seeing in terms of pricing spreads.
In terms of the innings I still think we've got a ways to go.
The <unk>.
Delivery rates the challenges presented by the GTS all of the indications that we're getting from our customer base is that demand will be strong for some time.
Which is why we continue to make investments in that business, which is why you saw an inventory increase this quarter and going back to Rob's question around.
The potential equity issuance, that's why we want to maintain a flexible balance sheet. So that we can continue to be nimble of that market and act when we see opportunity and obviously thats translating to high growth and high margin. So we still feel that that that dynamic has got a ways to go and then once you do start to see.
Sleep retired an aircraft go to tear it out there will be an even better period, where a more material is available some ultimately support.
The continued demand for that material. So we're looking forward to times when you actually start to see increased retirements and tear it out so that we've got access to more assets to fulfill the demand.
Got it Okay. Just a final question for me it seems like the government customers.
A source of relative weakness I think you've pointed out 1% growth relative to 'twenty four for commercial yes.
Yes, where are we on that dynamic changing it sounds like it doesn't change a ton in <unk>. So is that what I think you made the comment John high single digits to low double digits for sales growth in the fiscal third is is that why because that probably stays in that low single digit range.
Yes, I think youre exactly right that business right now obviously characterized by 1% growth area is relatively stable theres really two things. There one is our new parts distribution business that the government. This is down.
Considerably from where it was two years ago.
We mentioned that is a dynamic that we see some positive signs in the last few months we've seen some some.
Some increase in our bookings there so over the back half of this year, we're optimistic that we'll see any.
Government sales volumes out of our distribution business, but the program businesses is really the majority of this as you know a couple of years ago with the Afghanistan withdraw we thought downshift, we've had some short term wins as well as some long term wins that have offset part of that decline from Afghanistan, but.
But not fully and the backlog the pipeline of opportunities that we have in bid with the government right now Theyre just theyre just very slow to award.
We remain very confident about the value proposition that we have for the government and we've got some very meaningful programs out there.
We just need them to convert to a win but to your point, even once they do convert to a win by the time you clear what will likely be a protest on any one of those and go through a ramp up its unlikely you would see meaningful contribution from any one of those government programs until our next fiscal year.
Thanks, very much very helpful color.
Alright, thank you.
Speaker Change: Thank you one moment for our next question.
Speaker Change: And that will come from the line of Michael <unk> with <unk> Securities. Your line is open.
Michael as you're on mute, please UN mute yourself.
Okay. We'll go on to the next question.
And as a reminder, if you would like to ask a question. Please press star one one our next question will come from the line of Ken Herbert with RBC capital markets. Your line is open.
Hi, John Sean and John This is Steve strikeouts onshore kindergarten congrats on the acquisitions can you guys Hey.
Hey, great. Thank you good to talk to you.
So just following up on the margin outlook, probably to Rob's question.
As regard to your operating margins operating just operating margins were eight 1% in the quarter and I think at the Investor Day, you outlined about.
The 10% range I think you've just talked about it a little bit of pull forward. How should we think about the margins for the triangle business. I think you outlined about 150 basis points of expansion in repair and engineering is that just additive to those outlines.
Some of that M&A baked into that.
No. So I would say that that outlook. Given this past July was just organic outlook and as you think about bringing in a business like trial, then it just accelerates our ability to get to those.
Their business from an operating margin standpoint is about 18%.
And if you just look at kind of what we've done over the last 12 months a layer that on top of you a little bit north of 9%.
And then specifically in the R&D segment, where this will go.
Accretive to those margins as well, so really bringing some differentiated capability and that kind of shows up and that does show up in the margin profile of the business.
I appreciate that and then just switching gears to free cash free cash in the quarter was positive at about $10 billion or so can you maybe discuss some of the puts and takes for working capital in the back half of the year and then just any free cash flow expectations, you have with regard to the <unk> acquisition I realize it might be a little early to discuss those and get into those but you said that.
It was a strong cash business, so just kind of want to dig into that a little deeper.
So looking into the into the back half of the year I expect to be positive as we convert the inventory investments made in the first part of the year. We will continue as you heard John talk about it.
More supply becomes available we will continue to invest in that business, but in terms of cash flow conversions would expect the back half of the year to be positive.
As you think about the <unk> business one of the reasons, we like the business is not only does it have strong margins. It has strong free cash flow.
Because it's less working capital intensive than parts supply businesses.
So the working capital tends to be a bit more stable as you can grow the business and then from a capex standpoint, the facilities operate well and Capex is more in the five ish million dollars a year.
So when you think about kind of that 455 of EBITDA and $5 billion of Capex with working capital being relatively consistent it's a nice free cash flow free cash flow generator.
Awesome and then if I could just squeeze one more follow up on the government customer.
Are you guys thinking about I know you kind of guided down a little bit more so to low single digits for this year. How would you may be thinking about that with regard to the potential for an extended CR.
Yeah. So the guide for Q3 is high.
High single digits to 10% for this for this upcoming quarter and Thats just for the upcoming quarter now for the back half of the year just yet.
Yeah right right.
And we like anyone with.
<unk> end markets are paying attention to the pending.
And the programs. We're on are generally not impacted if that's a shorts.
Issue if it becomes longer of course, we like everyone else, we could be impacted but I would think that's expected and I think the other area you could see it on the margin is that we rely on government workers.
To help do parts supply into the government as you could see a little bit choppiness, there there'll be that those would be the two areas that you could see some impact depending on the length of the of the issue.
Awesome I really appreciate all the color there.
Thanks, guys I appreciate it.
Great. Thank you very much.
Thank you.
One moment for our next question.
And that will come from the line of Michael <unk> with <unk>. Your line is open.
Thank you satisfied with the message press, one to listen to your mortgage Preston.
Yes that was Michael's line, so speakers I'm showing no further questions in the queue at this time.
I'll turn it back over to you for any closing remarks great.
Great. Thank you very much we really appreciate the time and the interest everybody and it's an exciting time at AAR and looking forward to being back here next quarter to talk more in the meantime, hope everybody has a happy holiday season. Thank you.
Thank you all for participating. This concludes today's program you may now disconnect.
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