AAR Corp. (AIR) Earnings Call Transcript & Summary

Alright, thanks, and good afternoon to all of you. I'm grateful you could be with us today as we go over the results for our third quarter of fiscal year 2023. Ahead of my comments on those results, I want to draw attention to the Trax acquisition, which we made public yesterday. This is a pairing that Trax and we have been contemplating alongside each other for close to a decade, and we've collaborated diligently with the founders regarding the strategic vision for the organization once combined. Trax ranks among the top third-party suppliers of MRO and fleet management software anywhere in the world. More than 100 customers and roughly 5,000 aircraft are supported by it, with software that handles the full range of maintenance activities. Among those activities are numerous items, including inventory planning and purchasing, maintenance scheduling, engineering, work order processing, mobile task cards, electronic logbooks and personnel management. On top of that, Trax amounts to an essential software component, since it functions as a system of record mandated for airlines and MROs by the FAA and regulators elsewhere around the globe. Across more than two decades, Trax has taken on far bigger competitors and won, cementing its position as the top independent supplier of maintenance ERP software. Given how small they are, that market success says a great deal about how strong the product is, and our belief is that having AAR behind them will let them compete still more effectively. When it comes to AAR, this deal speeds up our digital strategy by adding a platform for delivering extra software tools and analytical solutions to our customers and forming a distinctive channel through which AAR products and services can be offered; what's more, it directly advances the objective we've stated of adding differentiated IP-based, higher-margin solutions into our aviation aftermarket offerings. The Trax leadership team is staying with the business, and the Trax brand and identity will be kept in the marketplace. Now to the quarter. Sales rose 15%, moving from $452 million in the prior-year quarter to $521 million, while adjusted diluted earnings per share from continuing operations climbed 19%, going from $0.63 per share to $0.75 per share. Sales to our commercial customers were up 28%, and sales to government customers fell 3%, which mirrors the wind-down of certain programs during the last fiscal year. On a sequential basis, sales to commercial customers rose 9%, and sales to government customers rose 15%. Our commercial parts activities carried forward the momentum we talked about last quarter. New parts distribution gained from the ongoing recovery in commercial flying, along with the contract wins we've had recently, which also fed into the results. And as we anticipated, the investments made in our USM activities last quarter are already producing early returns. We continue to concentrate on further opportunities for deploying capital in support of our parts activities; within MRO, we sustained the strong performance seen over the past several quarters, operating at nearly full capacity. I'm also happy to say that in our government business, we managed to spot short-term opportunities that produced sequential growth during the quarter. Profitability remained a highlight for us in the quarter, with adjusted operating margin reaching 7.6%. That's an improvement over the 6.7% we posted a year ago and lines up with how well we did in Q2. The improvement came from top-line expansion along with our ongoing capacity to take advantage of the cheaper cost base we put in place while the pandemic was ongoing. Turning to cash, operating activities from continuing operations brought in $17.4 million for the quarter. Net leverage finished Q3 at 0.8x EBITDA. If we adjust for the Trax acquisition on a pro forma basis, net leverage stood at 1.35x EBITDA. Given that position, we still enjoy considerable flexibility on the balance sheet to keep financing our growth. I'll now hand things over to Sean Gillen, our CFO, who will walk through the results in greater detail.

Appreciate that, John. Revenue for the quarter came in at $521.1 million, representing a 15.2% increase compared with the same period a year ago. Commercial revenue rose 28.1%, fueled by gains throughout our commercial operations. Government revenue declined 3% as a result of certain government programs wrapping up in our prior fiscal year. On a sequential basis, commercial revenue climbed 8.9% while government revenue increased 14.9%. Gross profit margin for the quarter stood at 18.1%, compared with 17.8% in the same quarter last year. Within our commercial business, gross profit margin was 18.1%, and within our government business it was 18%. These quarterly margins reflect ongoing strong results in our Parts Supply and MRO activities, along with favorable adjustments on government contracts tied to better recovery of overhead costs in contract performance. SG&A for the quarter totaled $56.7 million; that number includes a net $4 million tied to certain items excluded from our adjusted financial results, and those items are laid out in the earnings press release. Once those items are excluded, our SG&A fell to 10.1% of sales for the quarter, which fueled our adjusted operating margin result of 7.6%. Net interest expense came to $3.5 million for the quarter, versus $0.6 million a year earlier, pushed higher by rising interest rates and increased borrowings. Our effective tax rate for the quarter was 26.8%. For Q4, we'd anticipate an effective income tax rate of roughly 28%. Cash flow from operating activities from continuing operations was $17.4 million, which includes a $25 million inventory reduction during the quarter. We finished the quarter with net debt of $135.3 million and net leverage of 0.75x EBITDA, down from 0.88x EBITDA at the close of our fiscal Q2 in November. Turning to the Trax acquisition, we announced and closed that deal yesterday. Consideration consisted of $120 million in cash upfront, plus as much as a $20 million earnout tied to adjusted revenue performance for calendar years 2023 and 2024. That works out to a purchase multiple of 14x LTM EBITDA on the $120 million. Trax posted calendar year 2022 revenue of $25 million, with EBITDA margins of roughly 35%. We anticipate this acquisition will be immediately accretive to adjusted EPS, which will exclude the noncash amortization arising from purchase accounting. Keep in mind that the $20 million earnout consideration will show up in our SG&A across the 2-year period because of retention conditions, though we will exclude it from our adjusted results. Given the closing date, Trax will add a little more than 2 months to our fiscal Q4, and we'd expect it to contribute $3 million to $4 million in sales, with EBITDA margins near 35%. Interest expense for the quarter will be affected by the upfront $120 million at an interest rate of about 6%. As I mentioned, we expect Trax to be accretive to adjusted EPS in FY '24. Looking at pro forma figures, net leverage closed out Q3 at 1.35x EBITDA, while liquidity — combining what was left in cash on hand plus what we could draw on our revolver — came to more than $340 million. Our capital deployment priorities, as we've said before, follow a set order: first, investments in organic growth for our business; second, inorganic moves that create value by bringing in complementary capabilities; and third, returning capital to shareholders. Attractive chances to put money to work in those first 2 categories came our way across the past couple of quarters. Because of that, we chose not to buy back stock in Q3; at present, $58 million is left available under the $150 million repurchase program we announced in December of 2021. How we use that remaining authorization will be assessed across the rest of this calendar year, depending on other opportunities for deploying capital. Thanks for listening, and I'll hand the call back to John now.

Alright, thanks, Sean. As we look ahead, even though macro uncertainty and worries surrounding the worldwide banking sector are things every company is keeping an eye on, our optimism persists regarding the rebound in global flying activity and the overall durability of the aerospace aftermarket. The outlook for demand in international travel is especially robust, and our commercial clients continue to feel good about their bookings. That's feeding through into sustained strong demand at our hangers and for our commercial parts operations. We anticipate ongoing expansion in distribution of new parts, which stands to gain from both the demand recovery and the scaling up of contracts we've recently won. And when it comes to USM, supply availability is loosening. As we noted three months ago, engine green time availability is on the decline, which ought to push even more engine shop visits and the USM demand tied to them. On the MRO side, heavy maintenance demand remains robust, and we anticipate staying close to full capacity for the foreseeable future; we keep assessing chances to grow our network, in places where customers exist who've shown commitment and faith in long-term labor supply. Turning to our government segment, we remain in a solid position to secure further short-term and long-term programmatic wins, thanks to our best-value commercial best practices offerings. And we're still enthusiastic about what the new NDAA language could do, since it makes it easier for the government to move on more of what we offer. Our Q3 results came from strong performance across both commercial and government markets. For Q4, we anticipate ongoing commercial growth, though we see a modest sequential dip in our government business. Because of that, for Q4 overall, we're looking at total revenue and adjusted EPS that are comparable to or marginally better than what we just reported for Q3. We expect commercial growth to carry on and government growth to get back on track as FY '24 gets underway. On the subject of FY '24, we're planning an Investor Day in New York City on July 20. Further details will come soon, and we're eager to share more on strategy, just as we've done previously. Before we take questions, I want to once more share how thrilled I am about the Trax acquisition; we've been familiar with the company and its management team for 10 years, and I'm delighted that the chance to combine finally came about. To repeat what I told the Trax team yesterday in Miami, we view this as a one-of-a-kind chance to merge AAR's hardware with Trax' software to serve the global aerospace aftermarket in a manner that could become exceptionally potent over time. I'm eager for the impressive achievements we can accomplish together, and I welcome the tremendously successful Trax team into the AAR family. With that, I'll hand things to the operator for questions.

Congratulations on the deal, everyone. I'd like to begin right there, if that's okay. Could you describe the ways Trax might expand along a different path now that AAR owns it, compared with what it was doing before?

Sure, that's a terrific question. A few things come to mind. When you look at Trax next to certain other competitors out there, they rank as roughly the smallest purely by size, yet their market reach is quite wide, and over the past several years they've ranked among the top performers when it comes to penetrating the market. The primary factor behind their success has simply been how strong their product is. Their offering is arguably the finest available, which explains why they keep winning. What has held them back is simply that they operated as a sole proprietorship essentially in Miami. We think that teaming up with them means AAR, as a far bigger and well-capitalized supporter, can assist them in opening doors they otherwise might never have opened. That's one piece of it. On top of that, AAR, simply because of where we operate worldwide and the reach we have across the industry, should also be able to bring Trax to additional customers they previously might not have been able to get to.

Could you share a growth rate—what kind of pace have they been achieving, and what's possible from here?

Sure. We'll be able to give you something more precise down the road, but their expansion has been really quite impressive. To reiterate, our tracking of this business spans roughly a decade, and we've watched how their platforms have evolved. For instance, back when our conversations with them began, it was no surprise that most of their software ran on mainframes and desktops. Put differently, this was specific to one market. They've shifted onto a new platform, rolled out an entire set of fresh products — new apps, essentially — and they're bringing their users, across the coming generations, onto the cloud through an offering delivered as SaaS. So once that replacement offering gains traction, and once existing customers are shifted over to the updated platform, that's what fueled expansion over the past two years, and we anticipate it will keep fueling expansion across the years ahead.

All right; and following on from that, John, in what ways could the Trax operation propel your main established lines of business? Put another way, after those two are brought together, would it be overly hopeful to believe that this leads to additional components being sold, or expanded distribution, or similar?

I wouldn't call that hopeful in the slightest. As a matter of fact, that is precisely the way we look at it. At the end of the day, Trax is the platform relied upon by countless purchasers and planners at carriers across the globe. Moreover, it's a platform through which the actual buying from AAR occurs for the goods and services we provide; and what we intend to do is essentially move additional offerings of ours nearer to the clients and provide clients worldwide with wider reach into components and component availability.

All right, and only a few more brief items; given this wide-body upswing, what does that look like in the markets you serve? And do you feel any pull toward expanding into additional wide-body MRO work?

On that — yes, we are definitely watching it unfold. When it comes to MRO, our attention stays on what we do best, which centers on narrow-body. That is — over the past several years we've made significant moves to sharpen our concentration on that segment, and that is where we excel. On the parts side, however, especially involving engines, the powerful wide-bodies, that is a space we already occupy now, mostly serving the cargo sector. Yet as additional passenger planes begin flying, we foresee chances to grow the parts operation in support of that expansion.

All right. The one remaining item I'd like to raise with you, John, concerns your comments on USM strength along with recent investments. I'm hoping to get a clearer picture of where this USM cycle stands. My assumption had been that much of the material from parked aircraft and so forth would likely be used up at this point. So please bring us up to date on what's going on.

Regarding material from parked aircraft, I'd say you're right, yet the high retirement volumes people predicted for many years, especially early in the pandemic, haven't materialized. As OEM production rates increase and airlines re-fleet their aircraft, we do anticipate additional retirements down the road. That said, the sharp spike so many discussed for so long isn't something we anticipate. What we do anticipate is that curve growing steeper across the coming few years, which will supply additional material for our USM business.

Okay, regarding the government services segment, how does the recompete picture look, say, across the coming 12 months?

When it comes to programs we already hold, I can't, off the top of my head, think of any significant recompetes. That said, quite a few recompetes are underway at present involving programs we don't currently have, and we're bidding on those. If we win them, that would mean net new work for AAR.

Could you elaborate a bit more on what was said regarding the NDAA wording that opens up greater access to air services?

Sure. We touched on this somewhat during the prior quarter. In the end, what made it into the latest iteration of the NDAA that got approved was wording mandating that DoD branches evaluate purchasing secondhand components each time they enter the market. Consequently, our offering of used parts — which, as you’re aware, has performed very well in the commercial sector — now means that when agencies seek to procure parts, they must take that option into consideration; and we anticipate that as time goes on and these agencies gain a better understanding of the advantages of acquiring USM, it may become a growth market for us.

So, does Trax have any chances in the government space?