AAR Corp.

Good afternoon, ladies and gentlemen. Welcome to AAR's fiscal 2022 first 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. 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. These risks and uncertainties are discussed in the company's earnings release and the risk factor section of the company's Form 10-K for the fiscal year ended May 31, 2021. 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 to 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 first quarter fiscal year 2022 results. Our positive momentum continued with another quarter of solid results despite the continuing impact of the COVID-19 pandemic. Compared to the prior year period, sales were up 14% from $401 million to $455 million. and adjusted diluted earnings per share from continuing operations were up 206% from 17 cents per share to 52 cents per share. Our sales to commercial customers increased 52%, and our sales to government and defense customers decreased 17%. We are particularly pleased that our sequential growth from Q4 to Q1 was 4%, notwithstanding the fact that our first quarter typically declines from our fourth quarter as a result of seasonality in our business. Sequential growth in our commercial activities was 17%. This improvement was driven by our parts businesses, which is an encouraging indicator of returning demand. The strong performance in the quarter was also due to the robust demand for our airframe MRO services. Notably, the significant majority of our MRO volume has been on standard maintenance work as opposed to catch-up work. Our operating margin was 5.5% for the quarter on an adjusted basis up from 2.5% last year and 5.2% in the fourth quarter. For context, our margin this quarter was actually higher than two years ago prior to the pandemic, even though our revenue was down $86 million for 16%. This performance demonstrates the operating leverage that we have created over the last 18 months by optimizing our MRO operations, exiting underperforming activities, and reducing indirect and overhead costs. Turning to cash, it was another strong quarter as we generated $18 million from operating activities from continuing operations. We also continued to reduce the usage of our accounts receivable financing program. Excluding the impact of that AR program, our cash flow from operating activities from continuing operations was $26 million. Subsequent to the end of the quarter, we announced several new business wins. First, we announced an exclusive agreement with Arquin, a Transdyn company, to distribute engine actuation and other commercial aviation products. This award reflects the power of our independent distribution offering to component OEMs, as well as the strength of our balance sheet. Second, we announced a contract with the Department of Energy for the conversion and delivery of a 737-700 aircraft modified to allow the DOE to quickly transition between passenger and cargo modes. Like our prior C40 aircraft delivery contract with the U.S. Marine Corps, this contract demonstrates the significant cost savings available to government customers by procuring in the aftermarket. Finally, we announced an extension of our component support program with Volotea, a growing low-cost Spanish carrier, which reflects the market's continued demand for this offering and our ability to drive lower operating costs with superior operating performance. Before turning it over to Sean, I would like to comment on the critical role that AAR played in the U.S. withdrawal from Afghanistan. We had over 150 people stationed in country, primarily in support of our WASP program. Over a 36-hour period, our WASP team transported approximately 2,000 U.S. Embassy personnel to Kabul International Airport to support their evacuation from the country. All of our employees subsequently departed the country safely as well, and I'm exceptionally proud of our team's support of State Department personnel under very difficult circumstances. 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 of $455.1 million were up 14% or $54.3 million year-over-year. Sales in our aviation services segment were up 19.8%, driven by recovery in our commercial markets. Sales in our Expeditionary Services segment were down $17.7 million, reflecting the divestiture of our composites business and strong performance of the U.S. Air Force Pallet Contract in the prior year quarter. Gross profit margin in the quarter was 14.2% versus 12.1% in the prior year quarter, and adjusted gross profit margin was 16.1% versus 13% in the prior year quarter. This significant improvement reflects the cost takeout and efficiency initiatives we have implemented. As the commercial market recovers, we would expect to continue to generate higher gross margins given the fixed nature of some of our cost of sales and the higher margin nature of our parts business, which has not yet participated in the market recovery to the same degree as our maintenance business. As we indicated during last quarter's call, one of our commercial programs contracts was terminated during the quarter. We recognize 10 million of charges primarily related to this termination and an asset impairment. SG&A expenses in the quarter were 49.3 million, or 10.8% of sales. Excluding severance of about a million, this would have been closer to 10.6% of sales. This is down from 11.3% in the year-ago quarter and 11.2% in Q4. As a reminder, last year's results had some temporary cost savings due to salary and benefit reductions that were in place through Q2 of last year. Net interest expense for the quarter was $0.7 million compared to $1.6 million last year, driven by lower borrowings. Average diluted share count for the quarter was $35.7 million versus $35 million for the prior year quarter. With respect to Afghanistan, as we discussed on last quarter's call, we had in-country activity on two programs, our WAAS program supporting the State Department and our C-130 program supporting four Afghan Air Force aircraft. In conjunction with the State Department's exit from Afghanistan, we are winding down related activities and expect that to be completed later this quarter. The C-130 program is currently continuing with support of two of the four aircraft based in the UAE. In total, our FY21 sales in Afghanistan were $67 million. The margins on these activities were consistent with the overall loss program, which we have described in the past as being high single-digit operating margins. As John indicated, we generated cash flow from our operating activities from continuing operations of $17.5 million as we continued to reduce our rotables and inventory balances. In addition, we reduced our accounts receivable financing program by $8.4 million in the quarter. Our balance sheet remains exceptionally strong with net debt of $80.2 million and net leverage of only 0.6 times. Thank you for your attention and I will now turn the call back over to John.

Great. Thank you, Sean. Looking forward, we expect that demand for our MRO activities will remain strong as airlines continue to focus both on readiness to support the recovery and air travel and on preserving a healthy maintenance supply chain. With respect to parts supply, while we saw increasing levels of activity during the quarter, we expect stable performance in the near term as a result of the uncertainty created by the Delta variant. On the government side, the exit from Afghanistan, as well as the programs nearing natural completion points, will have a near-term impact on our business. However, our Department of Energy contract is an offsetting award that demonstrates the fundamental value proposition of our commercial best practices business model. In addition, we continue to build a solid past performance history. As such, we believe that over time, we remain in an excellent position to grow our government business through additional program wins and expansions of our current positions. Based on these near-term dynamics, we currently expect overall Q2 performance to be similar to Q1. While there remains uncertainty over the timing of the recovery, we are confident that a recovery will occur, and we believe we are exceptionally well positioned. We have emerged from the crisis with an even stronger balance sheet. Our government and commercial pipelines are full, and the operating leverage we have created positions us to continue to drive further margin expansion. With that, I'll turn it over to the operator for questions.

Thank you, speakers. Participants, we will now begin the question and answer session. To ask a question over the phone, you may press the star key followed by the number one on your telephone keypads. To withdraw your request, you may press the pound key. Again, that's star one to ask a question or the pound key to withdraw your request. Speakers first questions from the line of Mark Michael charm only approve of securities. Your lines now open.

Hey, good evening guys. Thanks for taking the questions here. Nice results as well. Um, maybe John, just, uh, the, the last comments you just made there, uh, two Q looking similar to one Q or you're talking both top and bottom line, or is that more just the, uh, the revenue side you were referencing?

I think at this point we're thinking up and down, but I would highlight that, again, we remain in an uncertain environment. But when we say similar, we mean top and down.

Okay. Okay. And is that, do you think, I mean, just trying to get a sense and maybe I'll feather this in, but I mean, you had really strong, I guess the implied sequential commercial growth in aviation services looked really strong. I mean, was that from... some of your additional maybe international customers and maybe I'm thinking Air Canada specifically coming online and as some of these other markets open up, does that continue to grow? And are we just looking at the top line kind of headwind all stemming from the WASA contract?

Yeah, so it was largely the demand. We had a great quarter in the commercial business across the board. The majority of it was really driven by the trading business, which is still considerably far off pre-pandemic levels, but they did have a nice sequential improvement. What we are seeing is that while we had kind of increasing levels of activity throughout the quarter, we have seen more stability and the pace of that recovery moderate in the last few weeks. And we attribute that to the pullback in the the bookings that you've seen from our commercial customers. Your comments on Canada are right on. We're really happy that Canada has opened up and that our customers there, notably Air Canada, are seeing more activity. That was not a considerable contributor to this quarter, but we do expect it to contribute to results going forward.

Okay, got it. Got it. Just on the on the gross margin. I know you obviously had on the adjusted gross margin. Good, good year over year growth, but sequentially. You know, it dipped down a bit and you just said parts was actually strengthening a little bit or recovering a little bit. What else went into, you know, the gross margin, you know, sequentially declining, you know, given the strong top line? Was it just more MRO, general mix or anything, any more color you can add there?

Hey, it's Sean. It was a little mixed on the government side. That was down a touch sequentially. As we talked on our Q4 call, there was a few events in Q4 that drove outsized profitability. on some government activity. So you saw a little bit of a decrease on that, which is what drove the sequential decrease from 16.5 to 16.1, but still feel very good about the overall profitability. And as we talked about, as parts continues to grow, that'll be accretive to the margin.

Got it. Just on the parts, and I mean, I'll take a stab here. I'm not sure if you guys will get much color, but any thoughts or anything you could provide on how the...

uh relationship with fortress is trending and sort of expectations there yeah um you know we the relationship is going very well that program is performing uh exactly how we expected fortress is a great partner and um doing everything they said they were going to do and that program at this point is uh is a full contributor i would say it's uh basically a full run rate um uh in the quarter and we expect those levels to be consistent uh throughout the rest of the year

Got it. Helpful. All right. I'll jump back in the queue. Thanks, guys.

Next question is from the line of Ken Herbert of RBC. Your line is now open.

Hey, John. Hey, Sean. How are you?

Hey, great, Ken. How are you doing?

Pretty good. Hey, John, I wanted to first see if I could ask you about retirements. And has your view changed on when we might see or start to see a more meaningful uptick in retirements and subsequently sort of USM availability? Or what are you currently seeing in that marketplace?

You know, we have seen more assets become available to us in the last few weeks. And there are some, and again, for competitive reasons, I don't want to get into too much detail, but we have seen more things come available that are interesting to us. I would not characterize that as too anecdotal and too soon to call it any sort of trend. That would suggest a meaningful uptick in retirement slash teardowns. But anecdotally, we have seen a few more come out recently. The activity that we saw this past quarter was largely due to material in stock.

Okay. Okay. That's helpful. And as you talk about your MRO business, it sounds like it's seeing some nice uptake. Is that all volume or are you starting to see some better pricing reflected in labor rates in that business?

The pricing that we've seen has actually been consistent over the last few quarters. We've worked very hard over the last few years to get our customer base down to a more focused long-term contract-based customers. So we're operating into long-term contracts in almost all of that business. So the pricing has been relatively stable. What we have been able to do, and this was by design based on the changes that we made during the pandemic, is really improve our efficiency inside the hangers. And by optimizing our footprint and aligning our hanger space with where we see the most labor availability, and that's full-time labor availability as opposed to contract labor, we've been able to achieve superior performance inside the hangars.

Okay, that's great. And just bouncing around, I know you had a program, a contract that you exited in the quarter. Can you just comment on sort of incremental risk you see and what's left of your program's business and how we should think about any of that risk moving forward?

Yeah, good question. We feel good about the remaining portfolio. You know, that was something that happened right after the end of the fourth quarter. And we characterized that when we announced the end of year results. And so, you know, in terms of anything new happening in this quarter, There wasn't anything. But, you know, that program contract, that was situational. And, you know, I would say kind of a one-off. And we feel good about the remaining portfolio. And very excited that we extended with Volatea. They've been a long-term customer. That airline is a great success story. And the volume of work that we've done with them has grown as they've grown. And we're excited to be on that contract for another few years.

Great. Well, thank you very much. Thanks, Ken.

As a reminder, it's star 1 to ask a question or the pound key to withdraw your request.

Okay.

Thank you, participants. I'll now turn the call back over to the management for final remarks.

Listen, we really appreciate everyone's interest and support and look forward to being back here in 90 days to talk about our second quarter.

Thank you. And that concludes today's conference. Thank you all for joining.

You may now disconnect.