AAR Corp. (AIR) Earnings Call Transcript & Summary

Hello, everyone, and thanks for joining us this afternoon for AAR's earnings call covering the second quarter of fiscal 2024. With us on the line are John Holmes, our Chairman, President, and Chief Executive Officer, along with Sean Gillen, our Chief Financial Officer. Prior to getting started, please note that what we say today might contain forward-looking statements, which are defined under the Private Securities Litigation Reform Act of 1995; such forward-looking statements carry risks and uncertainties that may lead actual outcomes to differ materially from what those statements suggest. As a result, they don't guarantee performance; you can read about these risks and uncertainties in the company's earnings release, in the Risk Factors portion of the annual report on Form 10-K covering the fiscal year that closed May 31, 2023, and in the Form 10-Q for the fiscal quarter that ended August 31st, 2023; when offering forward-looking statements, the company takes on no duty to issue updates reflecting future circumstances or events, whether anticipated or not. We'll also touch on certain non-GAAP financial information during today's call. You can find a reconciliation of those non-GAAP measures against the closest comparable GAAP measures in the company's earnings release. An on-demand replay of this conference call will be accessible shortly after we finish, on AAR's website. Right now, I'd like to hand things over to AAR's Chairman, President, and CEO, John Holmes.

All right, thanks, and good afternoon, everybody. I'm glad you could be with us today as we go over what we achieved in the second quarter of fiscal year 2024. But before we get into those results, I'd like to say something about the acquisition agreement we made public this morning. For a number of years now, our focus has been on strengthening where we stand in the marketplace for services that are proprietary and differentiated, and for a long time we've regarded Triumph Product Support as a top player in the repair segment of that market; in fact, over the 5-plus years since I took on the CEO role, I've held quite a few discussions with Triumph's CEO regarding the prospect of AAR buying this business. So, much like the Trax acquisition we told you about earlier in this year, this is something we've been thinking about for quite a while, and I'm thrilled that we've come to an agreement with Triumph. Our belief is that this deal will give greater scale to the component repair operation we already have, bring in next-generation repair capability, make our customer relationships around the world deeper and broader, and grow our footprint. The caliber of this business shows up in its margins, and we anticipate those will meaningfully improve our own margin profile. We expect plenty of benefits from combining the volumes of our existing Parts Supply, Repair & Engineering, and Integrated Solutions with the operations of this business. Triumph Product Support also brings a substantial DER portfolio along with considerable PMA development capabilities; our expectation is that this will speed up our growth in each of those areas. On top of that, its facility in Thailand will assist AAR in penetrating the Asian market further, which is seeing high growth. Lastly, this business includes a leadership team that is talented and accomplished. Taken as a whole, we expect this acquisition — which aligns squarely with the strategy we've stated — to be highly value accretive, and it brings significant scale, differentiated capability, operating margins of approximately 18%, a strong cash flow profile, and significant synergy opportunities. Now to the results: we turned in another strong quarter of financial and operational performance, producing record-adjusted second quarter earnings. To be specific, sales for the quarter rose 16% year-over-year, from $470 million to $545 million. Sales to commercial customers were up 24%, while sales to government customers rose 1%. Inside Parts Supply, sales grew 24% compared with the prior-year quarter, fueled by robust customer demand for used serviceable material and the ongoing expansion of our commercial distribution activities. When it comes to USM, our global sourcing team keeps securing material that's in high demand. A lot of that material needs repair work prior to being resold, and we keep working through extended turn times with our partner repair vendors. New Parts Distribution experienced 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 point, we've begun to see a slight uptick in our parts bookings with the government, which is encouraging. In Repair & Engineering, sales rose 8% compared with the prior year quarter, fueled by strong performance across our hangars and component repair operations. For integrated solutions, revenue rose 23% compared with the same quarter a year earlier. That came from more flight hours within our Power-by-the-Hour offerings, plus very solid results throughout our government programs. Trax likewise added to top-line growth in this quarter, and that integration keeps progressing nicely. On that point, Trax has a pipeline of opportunities that keeps expanding, since the value proposition of pairing Trax's industry-leading software with AAR's scale and financial backing is connecting with customers around the world. Over in Expeditionary Services, revenue fell 34% versus the prior year quarter, driven by a major drop in Mobility shipments of pallets to the Department of Defense. As a reminder, Mobility's products support U.S. troop movement, and that movement has not picked up in the current environment. The lower sales activity stems from funding being redirected toward the effort in Ukraine, and we anticipate a return to more normalized levels near the close of our fiscal year. Moving to profitability, our adjusted operating margin came in at 8.1%, compared with 7.6% in the prior year quarter. Operating margins grew in parts supply and Repair & Engineering. Trax also added to our overall margin expansion. What's more, this marks our eleventh consecutive quarter of year-over-year adjusted operating margin improvement. Our adjusted diluted earnings per share from continuing operations rose 17%, from $0.69 per share in last year's second quarter to a record $0.81 per share this year. On cash, we produced $17 million in cash flow provided by operating activities from continuing operations during the quarter. We keep seeing appealing opportunities to invest in our parts supply segment, which led to net inventory rising $32 million in the quarter. We expect those investments to keep driving growth for both USM and distribution. Our cash flow and ongoing EBITDA growth left leverage at quarter end at just 1.0x adjusted EBITDA, so our balance sheet stays exceptionally strong, which helped make possible the agreement to acquire Triumph's product support business. Shifting to new business, we had a number of wins announced during the quarter and after it ended. These wins, spread across multiple business segments within AAR, show how strong our offering is to customers. In Repair & Engineering, we announced an extension and expansion of our airframe services agreement with Alaska Airlines, including the planned corresponding expansion of our hangar capacity at Will Rogers World Airport in Oklahoma City. Like our previously announced expansion in Miami, this product satisfies every criterion we have laid out for MRO capacity growth, among them a supportive relationship with the airport local government, favorable labor market dynamics, and a long-term customer commitment. We are excited about this opportunity and want to thank Alaska Airlines, Oklahoma City Airport Trust, and everyone who made this possible. On the parts supply side, we shared news of a multiyear extension to our contract with MTU Maintenance, covering the provision of USM parts for Pratt & Whitney PW2000 engines. We also disclosed a fresh multi-year distribution arrangement for Woodward's fuel control products, which we'll supply to the Defense Logistics Agency through our Captains of Industry contract. And over in integrated solutions, Airinmar revealed a new multi-year services agreement with Pegasus Airlines — the Turkish low-cost carrier — covering warranty support services. Having said that, I'll hand things over to Sean Gillen, our CFO, so he can walk through the results in greater depth.

Appreciate that, John. Revenue for the quarter came in at $545.4 million, representing a 16.1% increase compared to the same period a year ago. Within that, commercial revenue rose 23.5%, fueled by gains throughout the majority of those operations, especially in parts supply, while government revenue grew 1.4%, largely on the strength of integrated solutions, though this was partly offset by lower results in new parts distribution, parts supply, and expeditionary. Our gross profit margin for the quarter stood at 19%, which is higher than the 18.3% reported in the equivalent quarter last year, and also above the 18.8% adjusted figure from that same prior-year quarter. On the whole, margin results were robust across all of our operations, with especially strong gains in commercial programs, plus the contribution coming from Trax. Within our commercial segment, gross profit margin reached 20.4%, while our government segment posted a gross profit margin of 15.4%, a figure that mirrors the weaker mobility performance John referenced. SG&A costs for the quarter totaled $65.7 million, a number that includes $3.1 million tied to acquisition and amortization expenses along with $2.6 million in investigation costs. Once those items are stripped out, SG&A came to $60 million, equal to 11% of sales. Net interest expense for the quarter amounted to $5.5 million, versus $1.5 million in the same period a year earlier, a change attributable to elevated interest rates and increased borrowings. Cash flow generated by operating activities from continuing operations was $17.4 million. Beyond producing cash, we kept putting money back into the business, which you can see in the $32 million build in inventories. Our balance sheet is still extraordinarily solid, sitting at 1x net leverage to Adjusted EBITDA, and that gives us the capacity to pursue both organic and inorganic investments, most notably the acquisition of Triumph Product Support that we've announced. Speaking of which, regarding that planned acquisition, as laid out in the release and the slides uploaded to our website, the consideration totals $725 million. We anticipate receiving tax benefits whose present value comes to roughly $80 million as part of this deal. After accounting for that tax benefit, the purchase price works out to $645 million, equivalent to a multiple of 11.7x EBITDA for the fiscal year ending March 2024, and 9.9x EBITDA once you include the $10 million in run rate synergies. A fully committed bridge facility is backing the funding for this acquisition. Completion of the deal depends on regulatory clearance and other standard closing conditions, and we intend to carry out a permanent financing alongside the closing that will involve debt and, depending on market conditions, equity. Assuming an equity issuance is included, our target net leverage at closing comes to roughly 3x. We anticipate starting to capture synergies soon after the deal closes and reaching the full run rate synergies by the conclusion of our fiscal year 2026. With the growth and cash flow prospects for both the target and AAR, we foresee additional deleveraging after the close. This transaction should be accretive to our adjusted earnings per share for our full year fiscal 2025. As has been our practice, our adjusted EPS and adjusted operating earnings are going to exclude non-cash amortization and comparable purchase accounting charges, which we expect to run roughly $20 million to $25 million annually. I appreciate everyone's time, and now I'll hand the call back to John.

Thank you, Sean. It's a pleasure to report that we once again achieved robust year-over-year top-line growth along with an increase in adjusted operating margin. Conditions in the commercial aviation aftermarket remained highly favorable, and our clientele has indicated robust appetite for what we offer throughout calendar 2024. On top of that, ongoing limits on deliveries of new aircraft, together with problems tied to newer generation engines, should spur greater need for mid to late life aircraft — and that, as you're aware, represents a central market for AAR. Regarding our parts operations, we anticipate further expansion in both USM and distribution of new parts. Our plans include putting capital into USM material as well as into new business wins and distribution, and we anticipate those investments will fuel our results moving ahead. Within Repair & Engineering, our hangars are running at close to capacity, and we anticipate that situation will persist for the foreseeable future. We're enthusiastic about the expansions we have planned at our Miami and Oklahoma City facilities. Over in Integrated Solutions, the Trax acquisition we made is delivering solid performance and making a positive contribution to our financial results. Our roster of government programs remains steady, and we're confident we hold a robust pipeline of opportunities with the Department of Defense and other government customers. As we shift our attention to calendar year 2024, our priority is turning that pipeline into new business wins. Turning to Q3, on the whole we anticipate continued growth in sales and earnings on a year-over-year basis. To be specific, we're expecting sales growth of high single digits to 10% versus the prior year, with adjusted operating margins in line with the quarter we just reported. This excludes any effect from the product support acquisition announcement. I take immense pride in what our team keeps accomplishing to generate the record results we've posted. The supportive macro backdrop combined with our capacity to execute remains a potent mix. What's more, buying Triumph Product Support substantially speeds up our strategy of adding distinctive, complementary, high-margin capabilities across our aviation services offering; we're beyond thrilled to bring Triumph Product Support's skilled team into the AAR family. With that, I'll hand things to the operator for questions.

Thanks. Hi, everyone, nice work on this transaction!

Hi, thank you so much, Rob.

I want to pose what might be a multi-part question about that, and after that I have something to ask regarding the business. But let's begin with the top line. I believe you said the deal ought to add to sales growth, yet which sales growth target do you mean? Does that refer to the coming twelve months? Or is it the long-term target you discussed in July? How should we frame that?

Yes, once we close the deal and it starts contributing, our view is that it will add to sales growth. And that 5%-10% figure we've referenced for the long term, in my view, also benefits from it, and we'll drive it upward toward the upper end of that range.

All right. Understood, and John, I believe you brought up synergies. I was just hoping to — you went over quite a few of them, but at a high level, if you could give a bit more detail on the cost side, and then also on the revenue side, the revenue synergies.

Yes, absolutely. That $10 million figure we mentioned is entirely cost-related; and, as you know, we anticipate that coming from several different areas, and our confidence in that number is extremely high. You see, with the 2 repair sites we already operate in New York and Amsterdam, plus the 5 locations we're picking up through Triumph, there's a decent amount of room to rationalize capabilities across all of them, and that will generate a substantial portion of the cost synergy. On top of that, a significant volume of repair work we currently outsource to support our Power-by-the-Hour program could be redirected to Triumph, though right now it goes to other suppliers. So we'd anticipate bringing that work together eventually, given the added capability we're gaining. Those represent the 2 primary components of the cost synergies. As of now, within that $10 million figure, we haven't included any revenue synergies, but you should expect that we see a great deal of potential to cross-sell to customers where Triumph is strong and we aren't, and on the flip side, to customers where AAR is strong and Triumph isn't.

Would it be reasonable to view this as a solid platform for your parts, letting you slot those into the Triumph facilities?

Yes, I'd say so — that's an outlet there. Another synergy linking the repair business and the parts business: since we must support the trading business, we hold a rotable pool that's fairly large, covering both rotable components themselves and structural components. Those components work synergistically with the repair business, since they also help with turnaround times. They supply exchange units along with extraction units. So the trading business and the repair business share synergies in that respect too.

Alright, and the final question on this topic goes to you, Sean. When we weigh possibly issuing equity against simply covering the whole amount with debt, the accretion looks roughly the same, yet dilution from equity would persist longer, I'd say, unless you repurchased shares. So what's the reasoning there, particularly considering your balance sheet?

Yes. That balance sheet, like you said, leaves us well positioned, and our approach, I'd say, involves aiming for 3x when we close, and that figure would factor in an equity issuance. Absent such an issuance, you'd likely land nearer to, well, 3.6x, 3.7x; and the idea behind it is simply to keep being more cautious with the balance sheet and to keep permitting investment that supports growth in the remaining businesses too; so we're looking at equity next to debt.

Understood. Alright, John, one final question, and it concerns the business. During the previous call, you mentioned certain headwinds — you know, ones stemming from a landing gear overhaul cycle wrapping up. I'm just curious whether additional ones lie ahead, whether in the core business or at Triumph, where either a headwind exists because an overhaul, some particular component cycle, is finishing, or a tailwind exists because another is beginning.

Off the top of my head, I can't recall any. What I'd say is that among all the repair businesses — heavy maintenance included, plus every operation Triumph is engaged in — landing gear is the most cyclical; so that's how it would be. Whether it's landing gear versus our remaining MRO operations, and definitely the operations within Triumph's portfolio, that would truly depend on the situation.

Thanks so much!

Thanks, Rob.

Hi there, good afternoon, and thanks for taking the question.

Hi, we appreciate you being with us. You chose a great moment.

Yeah, I get it. That's correct. John, perhaps to kick things off at a broad level regarding the Triumph angle, could you give us some background on what this deal accomplishes for you that you believe would've been overly challenging to achieve through internal efforts? And the reason I ask is this: how are you viewing what this contributes to AAR as a whole, and why does it, you know, accelerate the growth trajectory?

Yeah, excellent question. A couple of points on that. To begin with, I'd like to emphasize that this deal came about through negotiation. It wasn't a bidding process. Dan Crowley, who serves as CEO of Triumph, and I collaborated on it. And you know, it stemmed from the reality that for multiple years, as I noted earlier, we've believed this operation would be extremely complementary and strategic when paired with what AAR provides. So we felt quite good that everything fell into place, and we managed to secure a deal with Triumph. The benefits to us cover several areas. As I said, there are synergies tied to straightforward expense reductions, and those will result from rationalizing our footprint across seven combined locations, plus bringing in-house a substantial volume of work that AAR currently contracts out to support our flight hour program. Beyond that, Triumph possesses a tremendous amount of capability that required decades to build and would be virtually impossible to duplicate in today's environment. Their customer roster is outstanding and blue chip, with many relationships lasting decades. So those connections are extremely strong. Then there are the proprietary repairs stemming from their DERs — they hold more than 6,000 DERs. Once again, those required many years to establish. Plus a PMA operation that remains fairly modest relative to Triumph's overall scale, yet it's far ahead of our own PMA position, and it genuinely accelerates our PMA initiatives. So, you know, replicating everything they have would've demanded an extremely lengthy period and an enormous sum of capital. And the margin improvement involved here is quite substantial. You know, when you consider our long-range margin growth objectives, this moves them ahead by roughly two years, bringing AAR near our eventual double-digit target for operating margins — 10% and above.

All right, understood. Perhaps just one point of clarification there; regarding the PMA side, can you offer any kind of detail? I'm aware that you folks have mentioned doing that organically. What benefit does this bring you in that regard? Are these roughly the same kinds of components you intended to handle organically, or will this be complementary to what you're planning to do organically?

It complements what we consider doing organically, and their PMA work is mostly concentrated on interior components, which originate from the legacy Triumph Interiors business; they possess a solid portfolio in that area and a strong growth strategy for the PMA portfolio, yet concentrated on interior components, which complements the areas where AAR is focused.