AAR Q4 2023 Earnings Call Transcript

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July 18, 2023

There are 7 speakers on the call.

Operator

Good afternoon, everyone, and welcome to AAR's fiscal 2023 4th quarter earnings call. We're joined today by John Holmes, Chairman, President and Chief Executive Officer and Sean Dillon, Chief Financial Officer. Before we begin, I'd 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 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.

Operator

These risks and uncertainties are discussed in the company's earnings release and the Risk Factors section of Company's Form 10 ks for the fiscal year ended May 31, 2022 and Form 10 Q for the fiscal quarter ended February 28, 2023. In providing the forward looking statements, the company assumes no obligation to provide updates to reflect future circumstances or anticipated or unanticipated events.

Speaker 1

Chief Financial Officer.

Operator

Certain non GAAP financial information will be discussed in 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 JAR's Chairman, President and CEO, John Holmes.

Speaker 1

Thank you. Good afternoon, everyone. I appreciate you joining us today to discuss our Q4 and full year fiscal 2023 results. For the full year, sales increased 9% from $1,800,000,000 of $2,000,000,000 Our adjusted diluted earnings per share from continuing operations increased 20% from $2.38 per share of 7.5%. The strong performance reflects continued execution on our strategy to leverage our improved cost structure and capture growth in higher margin activities.

Speaker 1

Officer. For the Q4, sales were up 16% year over year from $476,000,000 to $553,000,000 Sales to commercial customers increased 31%, while as expected sales to government customers decreased 7% and Chief Executive Officer, we are pleased to be conducting a strong quarter of

Speaker 2

fiscal 2019.

Speaker 1

Adjusted operating margin was 7.8%, up from 7% in the prior year quarter and Chief Financial Officer. And adjusted diluted earnings per share from continuing operations were up 15% from $0.72 per share to a record $0.83 per share. Chief. We saw further growth in our commercial parts activities as global air travel continued to recover. In addition, as described in previous quarters, We saw engine green time availability continue to abate, which drove additional engine shop visits and associated demand for engine parts, which represent the majority of our USM offering.

Speaker 1

USM supply remains tight and our team continues to work to identify opportunities to acquire material Officer to meet the robust demand. Further, our recent new parts distribution contract awards continued to ramp up. During the quarter, we did experience some delays of OEMs due to supply chain issues, but we are working with our partners to receive the overdue material to ship against our backlog. Chief. MRO demand remains strong.

Speaker 1

And even though our hangers have been mostly full for some time, we were able to drive some additional volumes through our footprint and Chief Executive Officer. Labor availability remains tight, but our attrition levels have stabilized and our many partnerships with schools and other sources of talent Continue to serve us well. In Integrated Solutions, although our government work was down, we saw better performance in our commercial Power by the Hour programs Turban by increased flying internationally and the improvements that we have made to that operation over the last few years. With respect to cash, We generated cash flow from operating activities from continuing operations of $45,000,000 Our net leverage at quarter end was 1.07x EBITDA, which was down from 1.35x at the end of Q3 on a pro form a basis for the Trax acquisition. As such, our balance sheet remains strong and we have significant flexibility to fund our continued growth.

Speaker 1

And Chief Financial Officer. Regarding new business, we announced in March that we had agreed to acquire 9 Boeing 757-200 passenger aircraft Officer, equipped with 18 Rolls Royce RB211 engines from American Airlines. This investment provides us with feedstock to supply used serviceable material on the RB211 engine type to the 757 cargo market, which continues to be strong. It is also an example of the type of asset acquisition that our parts supply team makes to support the demand for USM. In addition, I want to mention the announcement that we made yesterday regarding the expansion of of Miami Airframe Maintenance Facility.

Speaker 1

Since making that announcement, we have received final approval from Miami Dade's Board of County Commissioners for the project. Our agreement with both the Miami Dade Aviation Department and United Airlines will increase our volume by 33% at that site. Officer. This project meets all of the criteria that we have previously outlined for MRO capacity growth, including expansion of an existing facility with government financial support, Chief Financial Officer. Thank you, John.

Speaker 1

Thank you, John. Thank you, John. Thank you, John. Officer. We expect to break ground in our fiscal Q2 and construction will take approximately 24 months.

Speaker 1

AR will be reimbursed by the Miami Dade Aviation Department for the expected $50,000,000 project costs. I would like to thank United Airlines Miami Dade County Mayor, Daniella Levine Cava Miami Dade Board of County Commissioners, Chairman of Oliver Gilbert and the Miami Dade Beacon Council for their partnership and making this important development a reality. Finally, I want to highlight that beginning with Q1 of fiscal 2024, we will be separating the reporting of what is currently our Aviation Services segment into 3 separate segments: Parts Supply, Prepared Engineering and Integrated Solutions. This separation better reflects the way we manage the company and how we view the areas of growth. It will also provide enhanced disclosure and insight to the investment community and other stakeholders.

Speaker 1

With that, I'll turn it over to our CFO, Sean Gillan, to discuss the results in more detail.

Speaker 3

Thanks, John. Officer. Our sales in the quarter of $553,300,000 were up 16.2% year over year. Our commercial sales were up 30.7%, driven by growth across our commercial activities and our government sales were down 7.1% due primarily to the completion of certain government programs in our previous fiscal year. We also saw a decline in defense distribution sales due to the timing of shipments from certain OEMs.

Speaker 3

Gross profit margin in the quarter was 19.5% versus 18.9% in the prior year quarter. Gross profit margin in our commercial business was 20% and gross profit margin in our government business was 18 point 5%. The strong commercial margin reflects the improved performance of our commercial integrated solutions activity that John mentioned and the contribution from Trax, which is a higher margin and Chief

Speaker 2

Executive Officer.

Speaker 3

SG and A expenses in the quarter were $70,800,000 Excluding certain tax expenses and other items that are detailed in the earnings press release, This figure was $64,100,000 or 11.6 percent of SITOs. This percentage is up sequentially, but down year over year. In Q1, we expect a downward sequential cadence in SG and A similar to last year. Net interest expense for the quarter was of $4,700,000 compared to $600,000 last year, driven by higher interest rates and borrowings. Officer.

Speaker 3

We expect our effective tax rate to be approximately 25% to 26% in Q1 of FY 'twenty four at approximately 27% for the full year FY 2024. Cash flow from operating activities from continuing operations was 45,300,000 We ended the quarter with net debt of $203,600,000 and net leverage of 1.07x EBITDA. In light of the Trax acquisition and other attractive opportunities to invest in our business, we elected not to repurchase stock during Q4. Officer. We continue to have $58,000,000 remaining on our stock repurchase program and we'll evaluate both usage of the remaining authorization Officer of expansion of the program over the course of the remainder of this fiscal year based upon alternative capital deployment opportunities.

Speaker 3

On that note, we are seeing attractive opportunities for investment in the USM market and may elect to deploy capital in Q1, which we expect will drive a use of operating cash in the quarter. Regarding our resegmentation, we plan to file an 8 ks today that provides financial results for the new segments for FY 2022 on an annual basis and for FY2023 on a quarterly basis. And Chief Financial Officer.

Speaker 4

The new Parts Supply segment

Speaker 3

will consist of both our used serviceable material and distribution activities. The Repair and Engineering segment will consist of airframe MRO, Component and Landing Gear MRO and Engineering. And the Integrated Solutions segment will consist of our government programs and commercial powered by the hour component solutions and Chief Financial Officer and our software solutions such as Trax and Aramar. Our Expeditionary Services segment consisting of Mobility Systems will remain unchanged. In addition to the segment changes, we are changing our measure of segment performance from gross profit to operating income.

Speaker 3

We frequently heard from investors and analysts on the desire for greater transparency, and we hope these changes will be well received. Thank you for your attention.

Speaker 1

And I will now turn the call back over to John. Great. Thank you, Sean. Looking forward, we expect the commercial market recovery to continue. Commercial air travel remains below pre pandemic levels by most measures and in most markets.

Speaker 1

And as you've heard from many major airlines recently, Interest in USM to remain robust. Although supply is constrained, it has been improvement and we expect it to continue to improve as airlines and Chief Executive Officer, we will take delivery of new aircraft and retirements increase. Notably, we do not expect additional USM supply to negatively impact our profitability. And Chief Executive Officer. Instead, we believe it will lead to more growth as the availability of USM is currently a growth constraint.

Speaker 1

In distribution, We expect to win more new lines with more OEMs, which will drive more growth. The continued market recovery and OEM supply chain improvement will also provide tailwinds. Chief. In Airframe MRO, we expect our anchors will remain largely full throughout the year and we are excited to be adding more capacity when the Miami expansion comes online. Initially, we do have capacity available to meet growing demand in our component and landing gear repair facilities.

Speaker 1

On top of that, We're also evaluating expansion at certain other of our airframe MRO locations where we have long term customer interest and access to labor. Finally, in our government business, our F-sixteen program in Europe has not yet fully ramped and will be a more meaningful contributor in FY 'twenty four and beyond. More generally, we remain confident that our value proposition in this market and our pipeline of opportunities will translate into additional growth over time. Officer. With respect to specific guidance, our operating environment remains exciting and dynamic, and so we plan to continue our current practice and Chief Financial Officer of providing an outlook on a quarterly basis throughout our FY 'twenty four.

Speaker 1

On that note, we expect to see Q1 sales Chief Financial Officer to be in the low teens year over year, driven by our commercial businesses and adjusted operating margins similar to what we just delivered in Q4. Officer. Looking ahead, we expect another year of margin expansion, albeit at a slower rate than the last 2 years. As you know, we are holding an Investor Day this Thursday in New York and we look forward to seeing you there to discuss our growth strategy, long term financial targets and commitment to continuing to deliver shareholder value in more detail. Before taking questions, I would like to take a moment to thank our team for delivering an outstanding year and our customers and other partners for supporting us.

Speaker 1

We continue to make our MRO operations more efficient, added several key distribution wins, expanded support of our USM customers, added an important new capability with the acquisition of Trax Chief Executive Officer and extended and upsized our credit facility in a challenging market. The result has been 9 consecutive quarters of adjusted operating margin improvement and Chief Executive Officer of record adjusted earnings while maintaining superb financial flexibility. Coming out of the pandemic, this success was not inevitable and once again, I'm exceptionally proud of our team. With that, I will turn it over to the operator for questions.

Speaker 2

And Chief. Thank and Chief Financial Officer.

Speaker 1

Chief Financial Officer.

Speaker 2

Our first question comes from the line of Chief Peter Osterland with Truist Securities. Your line is open.

Speaker 5

Hey, good evening. I'm on for Mike Ciarmoli. Thanks for taking our questions. So first, I just wanted to ask on the Miami facility expansion. Once construction there is complete, What's the timeframe for ramping up operations fully and how many new hires will you need to add in order to support that additional capacity?

Speaker 1

Yes. Great question and thanks for being on the call. Given the fact that we're expanding at an existing site where we've been operating for quite some time, Chief. Once construction is complete, we expect ramp up to actually go very quickly. We anticipate hiring about 250 new people for this expansion.

Speaker 1

And again, one of the criteria for expanding in a site is that we feel we've got access to a very strong supply of labor, Which is certainly what we have in Miami. So, we will be recruiting that talent well in advance of going live.

Speaker 5

All right. Very helpful. Thanks. And then I just had a follow-up on the margin outlook for the coming year, and Chief. Particularly given that you had some strong year over year growth this quarter, but SG and A excluding the track expenses, the margin was about flat versus the prior year.

Speaker 5

I guess just what do you need to see in order to kind of see SG and A expenses improve and start to trend closer to the target you mentioned in the past of around 10% of Sales. Is that still a viable target or are there any dynamics going on with wage inflation or anything else that has kind of changed the math there a bit? Yes.

Speaker 3

I'd say it still remains the target to be at 10% of sales. And I think to get there, what we'll need to see is just continued leverage on the top line on both commercial and government sales. As I mentioned, tracks is slightly higher in SG and A, but it doesn't move the needle massively for the whole company. And Chief Financial Officer. And even in this inflationary environment, we do still think that we can get to 10% of sales as we see more leverage on the top line.

Speaker 3

Chief Executive

Operator

Officer. Great. Thanks for taking the questions.

Speaker 1

Thank you.

Speaker 2

Thank you. Please standby for our next question. Our next question comes from the line of Ken Herbert and Chief Financial Officer of RBC Capital Markets. Your line is open.

Speaker 4

Hey, John and Sean, nice way to end the year. I wanted to first follow-up, John, on some of your comments on the USM marketplace. It sounds like you're Chief Financial Officer. Seeing more feedstock and it clearly sounds like you've got some opportunities very near term in the 1st fiscal quarter. Can you provide any more sort of granularity on Where you're seeing the opportunities and maybe how we should think about investments either in the Q1 or across fiscal 2024, specifically in the USM area?

Speaker 1

Yes. Great question and appreciate you being on the call. Yes, I would say generally speaking, we are seeing Chief of Loosening in the U. S. And Supply.

Speaker 1

And we have been able to deploy we were able to deploy capital throughout our FY2023. And Chief Financial Officer. Here's we're starting off FY 'twenty four, we're presented with some unique opportunities. And again, as you know, that's one of our big advantages in the market as when these things come up and there's still few and far between, we're We're able to move quickly. With respect to commenting on specific asset types, etcetera, I'd prefer to stay away from that given competitive dynamics.

Speaker 1

Chief. But we have a significant focus on engines and we are talking to all areas of market, whether that's Chief Commercial Officer that are going through portfolio changes, airlines that are going through fleet changes Chief Executive Officer, or even other brokers in the market that have assets available that meet contracts that we have to support.

Speaker 4

Okay. Very helpful. And based on your comments, it sounds like as you invest and you obviously Chief Financial Officer of some of the feedstock into USM. You're not expecting or in fiscal 'twenty four, the guidance doesn't imply any sort of Significant step down in pricing you're getting in the marketplace for the material, correct? I mean, it sounds like there's still enough of an imbalance that you should be able to get price On the USM, at least through the fiscal year.

Speaker 1

Yes. We definitely feel confident in maintaining our spreads throughout the year. Okay, great. And if I could

Speaker 4

just one final question. On the heavy MRO side, I mean, we continue to hear about Capacity constraint and number of maybe large captive airline operations maybe getting out sort of and Chief. Getting out of the heavy MRO business to some extent. So I think your capacity additions make a lot of sense and your it sounds like there's other opportunities there to maybe look to add capacity. Chief Executive Officer.

Speaker 4

How far out are you sold within or how's the backlog look maybe within the heavy MRO segment? And I guess more importantly, it seems like If there was ever an environment for you to get better labor rates, it would be right now. So can you comment on sort of what you're seeing from that standpoint?

Speaker 1

Chief. Yes. The commitment that we have from United that drove the Miami expansion and any of the other customers that we're talking to about potential other expansions, Those are multi year commitments. We're building permanent new capacity and so we want to make sure that we align with that. So we are absolutely seeing and Chief of Staffing and Communications.

Speaker 1

Because they anticipate capacity shortage for some time, being willing to sign multiyear agreements Officer. So that's encouraging. As it relates to labor rates, I think we've touched on this over the last couple of calls, but Generally speaking, we have a very productive dialogue with our airline customers about labor rates and we have contract by contract, worked with the customers to adjust labor rates, our price to them Officer, to reflect the cost of labor that we've seen in the market. And we've been able to, in an inflationary environment, drive Margin expansion in that business for maternal efficiencies, but also as a result of some of those discussions.

Speaker 4

Okay. And so is it fair to assume that as we get the new segmentation and we see the Sort of the repair business broken out a little bit better. We should see some of that drop to your bottom line in terms of There's an area for margin expansion within that business in particular?

Speaker 1

Yes. I mean, we can talk more about that on Thursday when we're together, but Broadly, yes, and you'll have visibility into the margins of that business. But I would say that our focus on margin expansion It's not going to come through price increases to the customer. That's really just to keep us even with the increasing labor costs. The margin expansion that we expect to gain over time is through investments in the facility.

Speaker 1

So Miami leveraging the fixed cost structure there to add 33% more volume and Chief Executive Officer, who are deploying technology throughout our hangars, whether it's paperless, drilling inspections, things like that, to get ourselves more efficient inside the operation. Chief. Okay, great. Thank you very much. Look forward to Thursday.

Speaker 2

Thank you. Thank you. Our next question comes from the line of Josh Sullivan with The Benchmark Company. Your line is open.

Speaker 1

Hey, good afternoon. Hey, Josh.

Speaker 6

Just to kind of follow-up on Ken's question there. Looking at scheduled care needs at the MRO facilities and Chief Financial Officer. And we hear about extended turnaround times. When you look at the market, when do you think turnaround times kind of peak?

Speaker 2

Chief Financial

Speaker 1

Officer. In terms of turnaround times in our own hangers, I mean, we've been running a pretty steady operation for the last several quarters. Officer. So we feel that we're actually operating quite efficiently in the hedges. As it relates to component repair turnaround time, again, we feel good about the TAT that We've had in our own shops.

Speaker 1

We do outsource a lot of repairs and we have seen those turnaround times increase. And Chief. To say that to try to predict when that's going to peak and come down is difficult. But I think what we're hearing and I'm sure you're hearing the same thing from and Chief of Repair Providers, many of whom are OEMs. We feel overall that the supply chain environment is improving.

Speaker 1

And Chief Financial Officer. And so this should be a better year than last year for turnaround times.

Speaker 4

Got it. And Chief Financial Officer.

Speaker 6

And then maybe as far as tracks, any KPIs you can share that you've completed or you're looking to complete?

Speaker 1

Chief Financial Officer. Nothing specific at this point. What I would say more generally is that, we're roughly a quarter into the acquisition. It's going very well. And Chief Financial Officer.

Speaker 1

The integration is on track or ahead of our plan. The team there remains extremely excited about the possibilities between our two companies. And Chief Financial Officer. On Thursday, we'll provide more detail and elements of the vision that we have for the Tracfit AR combination and I feel really good about it. Chief Financial Officer.

Speaker 6

Great. Thank you for the time.

Speaker 1

Thank you.

Speaker 2

Thank you. Please standby for our next question. Our next question comes from the line of Robert and Chief Financial Officer of Melius Research. Your line is open.

Speaker 6

Hey, guys.

Speaker 1

Hey, Ron. How are you?

Speaker 6

Pretty good. Thanks. John, I wanted to ask you just all this talk about heavy maintenance and maybe just to simplify it. Would you say With the unionization we've seen and all the traction that labor is getting in this constrained environment, would you say that The wage spread between captive airline labor and your labor is widening.

Speaker 1

I want to look at some data on that, but based on, yes, some of the increases that CFO. As a result of the new contract, I would say yes.

Speaker 6

Okay. So this should this just provides additional tailwind for you?

Speaker 1

Yes. And again, we just announced an expansion. There are other expansions that we're considering and we're only doing that where we're getting long term commitments from customers. Chief.

Speaker 6

Right. And then in terms of increased rates coming out of the OEMs, Boeing and Airbus starting to get those ramps, Have you seen any impact from that in your business as more aircraft come through? I understand they're nowhere near where they're going to be. CFO. I'm just curious the extent to which you might be seeing an effect from that.

Speaker 1

I would say nothing broad or a trend at this Chief Financial Officer. The closest thing was just we are seeing a loosening a slight loosening of Ply in the USM market. We are seeing more opportunities come up. But again, those are coming from all quarters, again, whether it's lessor, the Airlines, etcetera. So we assume that the slight increase in production that you're seeing out of the OEMs and Chief Financial Officer, is driving some of the fleet movement that's providing opportunities for us to acquire assets.

Speaker 6

Okay. And then Sean for you, just

Speaker 4

With the parts distribution

Speaker 6

business impacting cash flows, if we were to exclude that or maybe look long term, is there a free cash Flow conversion target that we should think about.

Speaker 3

Yes, I mean, we thought about that over time as well. Chief. We've got to stay away from giving specific guidance on that, which is in terms of net working capital, as you mentioned, we'll see volatility from time to time will be around new distribution agreements, which generally come with an upfront capital outlay or USM opportunities As we kind of I think saw back in our Q2 time period, we saw some big opportunity that we moved more aggressively on. Chief. But outside of that, you're obviously very focused on overall net working capital efficiency, AR and AP as well, and Chief Financial Officer.

Speaker 3

And continue to try to improve the cash flow profile of the company, which I think as part of the margin improvement that we've shown pre COVID today, I think you're seeing some of that improvement on the cash flow as well.

Speaker 6

Okay. Thanks so much. I'll save the rest for Thursday.

Speaker 1

Great. Thanks, Rob.

Speaker 2

Chief Financial Officer. We have a follow-up question from the line of Ken Herbert. Your line is open.

Speaker 4

Chief Financial Officer. Yes. Hey, Sean or John, can you comment on maybe what percentage of the growth in the quarter was tracks or what that contribution was?

Speaker 1

It was very modest. It was very modest this quarter, on track with expectations, but very modest. And Chief Financial Officer. And we would reiterate that we expect tracks to be accretive to our FY 'twenty four numbers. Chief.

Speaker 1

Okay, great. And then I'm sure we'll get into more

Speaker 4

of this on Thursday, but as you look for fiscal 2024, can Can you comment at least at a high level on sort of expectations for revenues are sort of low double digits, Chief. A fair starting point as we think about the full year?

Speaker 1

Yes. As we mentioned, we expect Q1 to be kind of mid teens growth and Chief Financial Officer, I'm sorry, low teens growth over Q1 last year. And Chief. And we'll talk a little bit more about long range growth targets when we're together on Thursday. Okay, great.

Speaker 1

Thanks, John. Thank you.

Speaker 2

Thank you. I'm showing no further questions in the queue. I would now like to turn the call back to management for closing remarks. Great.

Speaker 1

Well, thank you very much. We appreciate the time and interest to everyone, and we look forward to seeing many of you on Thursday. Officer. Thank you.

Speaker 2

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.

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Key Takeaways

  • Record Q4 results: Sales rose 16% year-over-year to $553.3 million with adjusted operating margin expanding to 7.8% and adjusted EPS from continuing operations up 15% to a record $0.83 per share.
  • Strength in commercial parts and USM: Commercial customer sales surged 31% as global air travel recovered, engine green-time scarcity drove increased shop visits, and tight used serviceable material markets prompted proactive feedstock acquisition efforts.
  • MRO operations at capacity: Hangars remained mostly full with strong demand in integrated solutions, attrition stabilized despite tight labor markets, and partnerships with schools are fueling continued workforce growth.
  • Strategic investments and expansions: The company agreed to buy nine Boeing 757s with 18 RB211 engines for USM supply, integrated the Trax acquisition, and secured approvals for a $50 million Miami MRO expansion to boost site volume by 33%.
  • Enhanced segment reporting: Beginning fiscal 2024, Aviation Services will be split into three new segments—Parts Supply, Repair & Engineering, and Integrated Solutions—to align with growth areas and provide greater transparency.
A.I. generated. May contain errors.
Earnings Conference Call
AAR Q4 2023
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