AerSale Corp Q2 FY2022 Earnings Call

Greetings. Welcome to AerSale Inc., Second Quarter 2022 Earnings Conference Call. Please go ahead.

Good afternoon. I'd like to welcome everyone to AerSale's second quarter 2022 earnings call. Conducting the call today are Nick Finazzo, Chief Executive Officer and Martin Garmendia, Chief Financial Officer. Before we discuss this quarter's results, we want to remind you that all statements made on this call that do not relate to matters of historical fact should be considered forward-looking statements within the meaning of the federal securities laws including statements regarding our current expectations for the business and our financial performance. These statements are neither promises nor guarantees, but involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results. Important factors that could cause actual results to differ materially from forward-looking statements are discussed in the Risk Factors section of the company's annual report on Form 10-K for the year ended December 31, 2021, and filed with the Securities and Exchange Commission on March 15, 2022, and its other filings with the SEC. We'll also refer to non-GAAP measures that we view as important in assessing the performance of our business. A reconciliation of those non-GAAP metrics to the nearest GAAP metric can be found in the earnings presentation materials made available on the Investors section on the AerSale website at ir.aersale.com. With that, I'll turn the call over to Nick Finazzo.

Thank you, Kristen. Good afternoon and thank you for joining our call today. I'll begin with a brief overview of the quarter and operational updates. And I'll then turn the call over to Martin to review the numbers. We produced another record quarter for AerSale with total sales of $139.6 million, which was up 51.9% compared to the prior year, and adjusted EBITDA that was up 35.2% to $41.1 million. Notably, this higher profitability was achieved despite the absence of $8.4 million in CARES Act payroll support proceeds that were received in the prior year as a result of the pandemic. This exceptional performance was achieved primarily through the broad-based success of our Boeing 757 passenger to freighter conversion program, which I'll refer to as P2F, combined with an improving backdrop of commercial demand for used serviceable material, which I'll refer to as USM parts. This notwithstanding, we think it is important to remind investors that our business can and will be lumpy quarter-to-quarter depending on flight equipment transactions during the period. This will be the case in 2022. As a disproportionate amount of flight equipment transactions occurred in the first half of the year. Turning to segment performance and beginning with asset management. Second quarter sales were $114.5 million, which marks an increase of 90% over the prior year. We sold a total of $92.5 million of flight equipment during the period, which included three aircraft, two of which were AerSale P2F converted 757s, a 747-400 freighter and three engines. While we do expect the pace of flight equipment sales to moderate substantially in the second half, based on delivery schedules, we remain positioned to continue the 757 P2F program through early 2024. Besides the six P2F conversions utilizing AerSale's Goodyear facility, we have committed to perform another 12 P2F conversions on 757s by third parties, with seven aircraft already owned by AerSale and available for conversion and an additional four in the final stage of purchase negotiations. Upon completion of these additional 12 aircraft, AerSale will have sold, leased or have available for sale or lease 18 P2F converted 757 freighters. Beyond the 757 P2F program, our feedstock pipeline has continued to markedly improve over the past several quarters, and current flight equipment purchase opportunities are the strongest we've seen in years. These are generally smaller packages of less than 10 aircraft or engines and include platforms such as the Airbus A320, A330, A340, and Boeing 737, 757, 767 and 777. We view this change in the market backdrop as a significant positive tailwind for our medium-term outlook, as it will enable us to leverage the approximately $347 million of cash and revolver capacity to increase our USM parts feedstock and aircraft available for sale or lease. This available liquidity becomes an even stronger market differentiator in an environment where the availability of financing for some of our less capitalized competitors has become scarcer, and the increase to their cost of capital has further eroded their smaller return opportunities. In our USM parts business, airframe and engine parts sales also grew compared to the prior year, reflecting the benefit of a stronger commercial backdrop, and recent feedstock acquisitions. As we look out beyond the next couple of quarters, we anticipate feedstock availability will improve further as we're able to execute on the broadening aircraft availability in the market. During the quarter, our leasing revenue also increased for General Electric CS6-ADC 2 engines, due to strong demand from wide-bodied freighter operators utilizing these engines. In consideration of the current soft lease market for older passenger flight equipment, we purposely reduced our aircraft leasing portfolio down to just one 737-400 freighter aircraft with a 747-400 freighter we previously had on lease being sold during the quarter at an exceptional price. With plenty of dry powder and utilizing our multi-dimensional value-added capabilities, we believe there will be ample opportunities to rebuild our specialized aircraft lease portfolio as the leasing market improves. As noted in the prior quarter, we own just one engine currently located in Russia and held by our Russian airline customer. Although they have not been using the engine since the Russian sanctions took effect and continue to reassure us they want to return the engine as soon as possible. It appears the political situation is stifling the process. Without certainty of whether this engine will ultimately be returned to AerSale and the lack of progress on our insurance claim. We considered it prudent to record an impairment for the full book value of the engine, which was taken this quarter. In our TechOps segment, total sales were $25.1 million, which declined approximately $6.6 million compared to the prior year. Lower TechOps revenue was the result of fewer aircraft in our storage facilities, as airlines have brought these aircraft back into service. Combined with the continued strategic capacity reallocation to our 757-P2F conversion program. This reallocation of resources results in a deferral of any revenue and associated margin for the work performed until the aircraft is subsequently sold, at which time, the value-added benefit will appear on the asset management side of the ledger. Although this may distort the timing and true value of the P2F work we perform at our on-airport Goodyear MRO, we still receive the full benefit of the higher value created at the company level. Our sixth and final AerSale converted 757 is expected to be completed by the end of the third quarter, which will open up that capacity for third party work in the fourth quarter. Regarding AerAware, I'm pleased to announce that together with our partner Universal Avionics and Elbit Systems subsidiary, we've completed the software validation process. This represents more than two years of engineering and development effort. And we're very excited to reach this important milestone. As we're nearing the commercialization phase of AerAware, we've stepped up our marketing efforts with airline operators and have received favorable feedback across the board. We've been hearing positive reviews about the system following our many demonstration flights, with pilots frequently noting that AerAware's advanced technology is decades ahead of anything existing today. The visual clarity of our enhanced Flight Vision System provides a strong advantage compared to older technology head-up displays that were developed over two decades ago. Importantly, AerAware product availability could not be timelier for airline operators, and other commercial air travel stakeholders, as the global airline industry struggles to meet higher passenger volume amid airport congestion and increasing weather-related delays. AerAware directly addresses and helps alleviate these important issues, while improving operational safety, minimizing diversions, fuel burn, and carbon emissions. As we believe final AerAware certification will be granted by the FAA in the near-term, we are investing in our ability to begin delivering AerAware to our prospective customers. To that end, in July, we ordered $33 million of the AerAware components from Elbit Systems' subsidiary Universal Avionics, so that we can begin installations at the earliest time. In summary, at the halfway point of the year, we're in an excellent position to deliver on our full year commitments. Our 757 P2F conversion program is on schedule. While the balance of our business continues to gain momentum as airline operators recover from the pandemic. Regarding our business development efforts, we're progressing toward commercialization of AerAware and continue to actively seek feedstock opportunities, with nearly $350 million of capacity ready to deploy, comprised of nearly $200 million of cash on the balance sheet and $150 million undrawn on our revolver. I want to thank all our employees and stakeholders for their support, which has allowed us to reach this record performance as we executed on our purpose-built, multi-dimensional integrated and adaptive business model. At this time, I'll turn the call over to Martin for a closer look at the numbers.

Thanks, Nick. I will start with an overview of our second quarter financial performance and end with our guidance for 2022. Our second quarter revenue was $139.6 million, which included $92.5 million of flight equipment sales. Revenue in the second quarter of 2021 was $91.9 million and included $42.7 million of flight equipment sales. Second quarter Asset Management Solutions revenue increased to $114.5 million from $60.3 million in the second quarter of 2022. Primarily on account of the flight equipment sales mentioned before. U.S. and parts sales also improved due to the pent-up demand and the ongoing recovery in passenger travel as compared to the prior year period. In addition, our leasing business benefited from higher volume and utilization of our leased flight equipment. Within our U.S. and parts business, we see an increasingly favorable market for feedstock availability, against the backdrop of growing demand for airframe and engine parts as airline USM parts consumption expands. In addition, demand for 757 P2F converted aircraft is expected to remain strong, and we are well positioned to monetize on an additional 12 aircraft, 10 in 2023 and 2 in early 2024. Second quarter revenue from TechOps was $25.1 million, compared to $31.6 million in the second quarter of 2021. That decline in revenue largely reflected lower storage maintenance at Roswell and Goodyear facilities as the return of aircraft by airlines into operations continued. In addition, we have reduced third-party capacity at our Goodyear facility due to the company 757 P2F conversion program. As you're aware, we have been able to generate higher margins from the sale of five internally converted 757s since the second half of 2021 as a result of this reallocation. We expect one additional internal conversion to be completed and sold in the remainder of 2022, after which we will transition to a third-party provider to perform an additional 12 conversions, which will allow us to increase our capacity for third-party work at Goodyear. The decrease in revenue from on-airport MRO activities was partially offset by higher revenue from our component MROs. Second quarter gross margin was 39.4% compared to 33.4% in the second quarter of 2021, driven mainly by a favorable product mix comprised of high-margin flight equipment sales. Selling, general and administrative expenses were $23.5 million in the second quarter, compared to $8.6 million in the second quarter of 2021. Largely on account of the absence of CARES Act Payroll Support Program proceeds received in the prior period. We received $8.4 million in Payroll Support Program proceeds during the second quarter of 2021 and did not receive any corresponding proceeds in the second quarter of 2022. We also incurred $3.9 million of non-cash equity-based compensation expense in the second quarter, which was de minimis in the second quarter of 2021. Income from operations was $31.5 million in the second quarter, versus $22.2 million in the second quarter of 2021. Net income was $26.5 million in the second quarter, compared to $16.5 million in the second quarter of 2021. Adjusted for non-cash equity-based compensation impairments and mark-to-market adjustments related to our Private Warrants, adjusted net income was $31.7 million in the second quarter, versus $21.8 million in the second quarter of 2021. Diluted earnings per share was $0.47 for the second quarter, compared to $0.38 in the second quarter of 2021. Adjusted for non-cash equity-based compensation impairments and mark-to-market adjustments related to our Private Warrants, diluted earnings per share was $0.56 for the second quarter of 2022 compared to $0.50 in the second quarter of 2021. Second quarter adjusted EBITDA was $41.1 million or 29.4% of revenues, while adjusted EBITDA in the corresponding year-ago period was $30.4 million, or 33.1% of sales. The improvement in adjusted EBITDA is primarily due to the increase in revenues from our higher margin businesses. In addition, adjusted EBITDA for the second quarter of 2021 reflected the benefit of $8.4 million in Payroll Support Program proceeds, for which there were no corresponding proceeds in the second quarter of 2022. Year-to-date, cash flow provided by operating activities was $41.2 million in the second quarter, compared to $8.6 million in the second quarter of 2021. The key drivers of the increase in cash generation were stronger operating income and flight equipment sales. At quarter end, AerSale had $197.2 million of cash on its balance sheet, and an undrawn revolver of $150 million. Finally, moving to our guidance for 2022 and summary. As a result of a strong second quarter performance and a supportive outlook for the remainder of the year, we are reaffirming our 2022 guidance for revenue of $420 million to $450 million and adjusted EBITDA of $80 million to $90 million. The implied reduction in performance in the second half as compared to the first half reflects an earlier than anticipated sale of our 747-400 freighter at the end of the second quarter, which was planned for the third quarter. Also deferral of two 757 aircraft to the 2023 third-party P2F conversion program in order to benefit from higher margin returns and consideration of the ongoing risks in the global economy. Looking forward beyond 2022, we expect flight equipment deliveries on our 757 P2F program to accelerate in 2023 coupled with meaningful contributions from AerAware as product deliveries ramp up. In summary, we are excited to report our record performance this quarter, we have again demonstrated the strength of our purpose-built model as well as our excellent execution capabilities. We believe we are well positioned to continue to generate strong returns to all our stakeholders. With that operator, we are ready to take some questions.

Thank you. The first question we have is from Gautam Khanna from Cowen. Please go ahead.

Hi, good afternoon guys. I was wondering if you could elaborate on the AerAware order you placed with Universal. And could just talk about how once it's approved by the FAA, and once an airline has placed an order how quickly can these actually be manufactured and installed, and just sort of what's the process around that you're planning for now?

Okay, good afternoon Gautam. The order we placed with Elbit Universal for AerAware components is designed to ensure that we have enough equipment to begin delivery and complete the conversion process. This involves modifying the radome, installing wire harnesses on the aircraft, mounting the eye tracker, and creating a space in the eyebrow bin for the head wearable display. We will conduct system tests, calibrate, and obtain the supplemental type certificate authorization for the specific aircraft. We need to prepare for installing a full fleet of completed systems. The first step is to carry out all these tasks while also installing the components. We believe this can be done over a few days. However, aside from the installation set necessary for aircraft certification, we do not need a large order of components to start delivering AerSale’s share of the AerAware converted aircraft; we only need a sufficient installation kit, modified radome, and several component sets to certify one aircraft. A large order could take months or even years to fulfill, depending on its size, but that would not hinder our ability to begin our conversion work or make sales. Once the hardware is available, we expect to finalize the reinstallation of the hardware overnight after the aircraft has been certified and prepared to accept all the components produced by Elbit Universal. So, with a large order, we could start our part immediately, and once Elbit Universal meets the manufacturing demand for the component pieces, we would complete the installation, finishing their portion of the job while our half would already be completed.

Okay, interesting. Do you have any clarity on whether the FAA still requires that more than half of the operators' fleet have the AerAware system in order to fly them? Or has that changed at all?

That's not changed yet. Our understanding is now whether that's an operator requirement or an FAA requirement, we're still not sure we're hearing it's an FAA requirement. But it makes sense that before an operator would release a new system into their operation, that they would have all the pilots trained on the system, they would have enough equipment installed in the aircraft so that as pilots are rotating from one aircraft to another, that they hop into an airplane with AerAware installed, they already been trained, they know how to use it, and there's enough aircraft flying around out there to get some proficiency using it. So whether it's an FAA requirement or not, I think it's prudent that the airlines, wait until they get half their fleet modified before they start using the system.

Okay. And do you guys have a timetable on when the earliest as soon as you might actually get approval? And how has it gone, I think it just kind of described your interactions with the regulatory bodies since the software package was finalized and submitted?

A few weeks ago, we conducted another round of familiarization flights with the Human Factors division of the FAA. Their engineers assess whether pilots can comfortably wear the head-mounted display and ensure it does not interfere with their operation of other aircraft systems. They requested these demonstration flights to familiarize themselves with the system ahead of our certification flights. This was our third set of tests involving different FAA personnel from the Atlanta and Seattle regions, along with the Human Factors team. We believe all necessary FAA engineers and test pilots who will participate in our certification tests have already interacted with the aircraft and understand its functions. They will be able to validate that the airplane performs as we claim, operates effectively even in adverse weather, and does not cause any interference. We see the certification flights as a final confirmation step. We feel confident that we have successfully demonstrated the system to the relevant FAA people who will ultimately grant approval, making us very optimistic as we approach the conclusion of this process.

Okay. And last one, before I turn it over, I just wanted to ask, you mentioned that the market for acquiring USM seems to be showing some life and that some of the competition is waning a bit. So maybe it's more of a buyers' market. I was wondering if you could elaborate on kind of what's in your pipeline of pursuits, maybe just by size, are you in fact seeing a more rational market right now in terms of bids that are prevailing and/or who is actually in the market competing against you, for these assets? Any color there would be helpful? Thank you.

We believe that the seller's market is beginning to lose momentum. Leasing companies and airlines that have been dealing with idle equipment are now reassessing their strategies. After a prolonged period of storing aircraft without finding buyers, leasing companies have now reached a point where they are determining which components—such as engines or landing gear—they will retain for immediate needs and which aircraft they will sell. Consequently, we are increasingly receiving opportunities to acquire various types of aircraft, whether complete, partially complete, or in need of significant parts. Our extensive experience allows us to effectively handle aircraft that may lack essential components like engines or landing gear. We have the capability to restore these aircraft because we have developed the necessary infrastructure over the past decade. This positions us favorably compared to our competitors, who may have financial resources but lack the comprehensive capacity that we possess. Therefore, they struggle to find profitable avenues for less-than-complete aircraft or those under lease. It is not entirely clear whether the market itself is shifting or if it is simply the evolving landscape of buyers and the maturation of our business model that enables us to excel in capitalizing on midlife equipment. Over time, leasing companies have held onto aircraft for extended periods due to a lack of storage options, which led to conditions where leasing companies resorted to leaving equipment with non-performing lessees. However, as these aircraft are now being recovered from storage, we are witnessing an increase in availability from leasing companies and airlines that previously faced performance issues. While we are uncertain if we will completely replenish our previous storage capacities, it is evident that we are seeing a resurgence in available aircraft. Overall, we are well-positioned to take advantage of this influx of flight equipment and to extract more value from this equipment than others in the industry.

Thank you.

Welcome.

Ladies and gentlemen, it seems we have reached the end of our question-and-answer session. And I would like to turn the call back to Nick Finazzo for closing remarks.

Thank you. We’ve had another record quarter, which is great. However, we are performing just as we anticipated, perhaps a bit ahead, due to the successful closing of the 747 transaction that we initially expected in the third quarter, but it actually occurred at the end of the second quarter. We're excited about that. It’s important to remain focused on our expectations for the year. Although we are on track to meet our annual guidance, we are not increasing it at this time. We plan to assess upcoming opportunities in the next quarter and consider if an adjustment to our guidance is warranted. I am optimistic that we will find a way to exceed our projections based on our current performance. However, even if we don’t, we have taken steps this year to defer some revenue into 2023. We have the largest backlog of available equipment in the company's history, with ten 757 freighter conversions contracted for next year and two scheduled for 2024. This significant amount of equipment positions us well for the coming year. Additionally, we decided to hold two 757s that we initially planned to sell this year, as we believed we could achieve a better return by converting them rather than selling them as is. This strategy allows us to move revenue from 2022 to 2023 in pursuit of a higher margin, reflecting our confidence in meeting our guidance. I want to emphasize the milestone we reached with our AerAware product. Completing two years of engineering development and software validation is a substantial achievement. Our $33 million equipment order underlines our confidence in getting this system certified soon, and we are anticipating strong customer demand. We feel very positive about our position with AerAware as we move into 2023 and beyond. While we recognize the ongoing work ahead, we are confident about concluding 2022 successfully and the prospects for 2023 and 2024, considering the number of completed 757 conversions and the commercialization of our AerAware product. If we don’t see progress by the end of this year, we fully expect it in 2023. Thank you for your attention, and I wish you all a great evening. We look forward to seeing you next quarter. Goodnight.

Thank you, sir. Ladies and gentlemen that concludes today's conference. Thank you for joining us. You may now disconnect your lines.