AAR Corp. (AIR) Earnings Call Transcript & Summary

Thanks, and good afternoon, everyone — appreciate you being here. We feel a great deal of pride in the record results we posted for FY '24. My gratitude goes out to our team for the relentless work they put in. AAR moved its strategic initiatives forward, honed its priorities, closed the biggest acquisition in our history, and delivered strong execution throughout the organization; structural tailwinds are working in our favor, coming from high volumes of air travel alongside an aging fleet, and those forces fuel demand for the aftermarket services we provide. Our organization has never been as tightly focused as it is now across our 3 main segments: Parts Supply, Repair & Engineering and Integrated Solutions. In all 3 of these segments, we are putting capital to work to fuel growth, boost our efficiency and produce stronger margins. The payoff from those investments showed up in our FY '24, and we anticipate that carrying into our FY '25. So with that, let me get into the FY '24 results in greater detail. We posted record full year sales of $2.3 billion, a rise of 17% from the previous year. Our adjusted operating margins climbed from 7.5% to 8.3% in fiscal 2024, and that figure captures just one quarter of ownership of the higher-margin Triumph Product Support business. On top of that, we produced record adjusted diluted earnings per share from continuing operations of $3.33, versus $2.86 a year earlier. Our fourth quarter gave us a record finish to a record year. Sales were up 19% year-over-year, powered by the Product Support acquisition's impact along with robust results in our distribution and government-integrated solutions activities. Adjusted operating margin rose by 150 basis points year-over-year, moving from 7.8% to 9.3%, thanks to what Product Support contributed and our strong execution in both Parts Supply and airframe maintenance. Because of certain portfolio changes we've implemented, I'll now walk through the results with somewhat more granularity for each of our 3 segments. Parts Supply. Parts Supply stands as our biggest and most profitable segment, and it's where we see a truly substantial opening for organic growth. Within this segment sit 2 activities, new parts' distribution and use serviceable material, or USM. Distribution accounts for roughly 55% of Parts Supply sales. Distribution performed exceptionally well in the fourth quarter, marking the tenth consecutive quarter of double-digit organic growth. Revenue climbed 16%, propelled by extra government volumes, market share gains and sustained commercial demand strength; we hold the position of largest independent distributor of OEM parts, and that independence is a crucial strategic edge, removing conflicts and enabling our OEM partners to serve every aircraft type. We maintain deep ties with a handful of key OEMs, and every one of those relationships is exclusive. We keep signing new exclusive agreements, and the quarter brought several meaningful wins, among them our multiyear contract extension and expansion with Sumitomo Precision Products to distribute its V2500 starter and valve components, our new multiyear agreement with Triumph Product Support covering its actuation product line and the expansion of our agreement with OTTO engineering to distribute electromechanical components. We're bullish on the prospect of picking up more share of the market and bringing on additional distribution lines at a comparable rate moving forward, especially as we expand into electronic components and the general aviation end markets as a whole. USM. Roughly 45% of total Parts Supply sales come from USM. It also turned in a solid quarter, with sales climbing 1% versus the prior year and 7% higher than the previous quarter, even with supply conditions that were extraordinarily tight. As a reminder, in this line of business, we purchase used aircraft engines, put together a plan for disassembly and repair, send individual parts out to be refurbished, and then offer them to our customers at considerable savings compared with new part options. We likewise buy and then resell complete aircraft and engines, an activity that matters a great deal and can introduce unevenness into our results. If you set aside those whole asset sales, USM parts sales grew 38% during the quarter. That underlying expansion in recurring used parts sales speaks to our robust market position, supported by deep supply relationships for sourcing parts, substantial know-how for assessing assets, and a top-tier global sales force; we keep benefiting as more airlines and MROs embrace USM and capture the advantages of buying used, and we think this will remain a favorable force for our business for many years ahead. Whole assets like engines, especially, are seeing strong demand because of the problems with the GTF and other new engine variants, and that, combined with a fairly low number of aircraft retirements, is making whole asset availability tight. Even so, we anticipate that supply pressure will ease across the coming few years, driven by the rebound in new aircraft production and better performance from new engine variants. That should mean more aircraft and engine retirements, which in turn will bring greater availability of individual parts and whole assets and let us keep up our overall growth in USM. Repair & Engineering. Now for Repair & Engineering, this segment covers airframe heavy maintenance and component repair, which includes Triumph Product Support along with our PMA parts efforts. Revenue rose 51% in the quarter. Setting aside the Product Support acquisition, revenue came in relatively flat < >; even so, our hangar capacity expansions in Miami and Oklahoma City are still on schedule to begin operating in the second half of calendar 2025. Once complete, those expansions will contribute roughly $60 million in annual sales. On March 1, at the start of the fourth quarter, we completed our purchase of Triumph Product Support, which adds scale and a differentiated repair capability. That acquisition came in ahead of what we expected in Q4, and we're only starting to unlock meaningful additional value; on the cost synergy side, we're beginning to combine our current Long Island facility with the Product Support sites in Grand Prairie, Texas and Wellington, Kansas. We remain on track to hit the previously announced related cost synergy target of $10 million by Q1 FY '26. This move also allows us to perform repair work internally, which now supports our commercial programs along with USM refurbishment efforts. On top of that, we're putting our skilled commercial aftermarket sales team and our government business development assets to work so that Product Support can grow even faster. Our PMA initiative keeps moving forward as well. Several parts have received FAA approval, and there's a substantial additional pipeline we're actively developing. Right now we're working to fold this initiative into the existing PMA business that arrived through the Product Support acquisition, and we stay dedicated to building this combined PMA effort into a business of real significance within the coming several years. Integrated Solutions. Now for Integrated Solutions — in this segment, we help government and commercial aircraft operators manage logistics and supply chains, plus we offer the Trax software product. Government customers make up most of what this segment does. Our programs run long term, with an average tenure of 5 years, which means this is an annuity business. Broadly speaking, we handle aircraft operators' aftermarket needs programmatically, spanning parts, maintenance, sourcing and logistics. Segment revenue rose 10% versus a year ago, with higher volumes in our state department and F-16 programs. As you're aware, we bought the TRAX software business a year ago, and that integration has proceeded well. TRAX is a best-in-class maintenance ERP offering, serving nearly 150 airlines and MRO customers around the world. We're expanding the core TRAX business by bringing it to customers it may not have reached before, and we're preparing the way for TRAX to become a new sales channel for our core parts and services offering. TRAX is a high-margin business and has a long runway for growth. That wraps up the update on our 3 core segments. Expeditionary Services, our fourth segment, is non-core for AAR. Sales there fell 30% because volumes in both pallets and shelters stayed depressed as the government puts spending priority on products that support Ukraine forces. That said, we now have visibility into funding going forward, and we expect volumes to return to normal during FY '25. All in all, I couldn't be more proud of the quarter and the year we delivered; and with that, I'll hand things over to Sean.

Thanks, John. For the quarter, total sales rose 19%, reaching $657 million. If you strip out the effects of the product support business we acquired recently, organic revenue growth came in at 5.5% for the quarter. Sales to commercial customers on a consolidated basis were up 20%, or 4% organically, with all 3 of our core segments showing growth. Commercial distribution sales really stood out, since we keep pushing growth on product lines that already exist while also expanding lines we've newly won. Government sales rose 15%, or 10% organically — better than the 7% decline we saw in the prior quarter. That organic increase came from a continuing recovery across our government program activities plus higher order volume for our new parts distribution activities. Adjusted operating profit margin went up 150 basis points, moving from 7.8% to 9.3%. Organically, adjusted operating margins were also higher by 60 basis points, thanks to Parts Supply and airframe maintenance. Adjusted EBITDA margin climbed 200 basis points, from 9.6% to 11.6%. Over the medium term, we have a clear road map for continued margin improvement as our mix shifts toward segments with higher margins. We realize the Product Support synergies. We keep rolling out our initiatives to improve airframe maintenance efficiency, and the new airframe maintenance capacity expansion projects come online. Turning to our numbers: net interest expense came in at $18.7 million for the quarter, which reflects how we financed the Product Support acquisition, and we're anticipating that Q1 interest expense will land at roughly the same level as Q4. On the share side, average diluted shares for the quarter totaled 35.4 million. Our effective adjusted tax rate moved up, going from 23.6% to 26.4%. Looking ahead to FY '25, we're expecting an effective adjusted tax rate of about 28%. Adjusted diluted EPS rose from $0.83 to $0.88, which is a record, driven by the benefits of our growth and margin expansion. The Product Support acquisition was slightly dilutive this quarter, though we anticipate it will be accretive to earnings in FY '25. With that, I'll move on to the detailed results by segment. Parts Supply revenue rose 9%, reaching $260 million. That came from a 16% increase in distribution and 1% growth in USM. Distribution's expansion matched the double-digit gains we've seen across the past few quarters, reflecting our ongoing market share capture. During the quarter, growth got a boost from the continuing ramp-up of our Arkwin and AeroControlex lines, along with larger purchases from both the U.S. and foreign governments. USM had a solid quarter, with USM parts sales climbing considerably; even so, a drop in USM whole asset sales—supply is still tight for these bigger transactions—mostly canceled out that gain. During the quarter, adjusted operating margins for Parts Supply climbed 130 basis points, hitting 13.5%. Distribution drove that gain, thanks to advantages from scale and mix. Higher distribution sales to government customers also played a part in the margin uptick. Repair & Engineering sales jumped 51% to $216 million, though on an organic basis they were flat, as hangar expansion was offset by reduced landing gear repair activity winding down. Product Support has been integrating well, and that deal brought in $73 million of revenue in Q4. Demand remains strong for our heavy maintenance and component repair offerings, and we intend to continue driving growth in those areas. During this quarter, Repair & Engineering saw its adjusted operating margin rise by 490 basis points to reach 11.5%. That improvement came from the inorganic contribution of Product Support as well as continued efficiency gains at the hangars. Going forward, we expect this segment to deliver further margin growth by realizing Product Support synergies, rolling out our paperless hangar initiative, and bringing capacity expansions online in FY '26. Integrated Solutions posted a 10% sales increase, reaching $163 million, driven by improvements in our state department program, the F-16 program, and TRAX. For the quarter, Integrated Solutions' adjusted operating margin declined 120 basis points to 5.6%, which mirrors the mix across government programs. Moving on now to consolidated cash. Continuing operations generated $25 million of cash from operating activities this quarter, helped by a $7 million reduction in non-product support inventory. Thanks to that cash inflow and our EBITDA improvement, net debt to adjusted pro forma EBITDA fell from 3.6x at the time the Product Support acquisition closed to 3.3x by the close of Q4. That deleveraging is a result we're pleased with, and we'll continue weighing opportunities to put money into the business versus paying down more debt. Our balance sheet and capital structure leave us with plenty of flexibility to operate the business and make decisions that drive the most shareholder value. With that, I'll turn the call back over to John.

Okay, thanks, Sean. Since this will be the first complete year of results that includes the margin-accretive Product Support acquisition, we're revising the 3- to 5-year adjusted operating margin objective we shared at last year's Investor Day so that it reflects the accretive effect of that Product Support acquisition; previously, our expectation was 9% to 10% plus adjusted operating margins. We're raising that to 10.5% to 11.5% plus because of the Product Support acquisition and because our confidence has grown in reaching the targets we set out a year ago. So that comes to adjusted EBITDA margins in the 12.5% to 13.5% range. Over the coming 3 to 5 years, we have confidence in delivering organic sales growth averaging 5% to 10% annually, along with average yearly growth of 10% to 15% in organic adjusted EPS. Turning to FY '25, we're expecting growth to continue along with further margin expansion. In Parts Supply, new parts distribution should keep gaining from new distribution lines ramping up as well as rising commercial aftermarket demand. In USM, demand should remain quite strong, but revenue growth will likely be held back by tight supply until additional aircraft retirements occur over the next few years. On the repair and engineering side, our hangars for airframe maintenance should remain mostly at capacity until the Miami and Oklahoma City expansions become operational in FY '26. Until then, we anticipate squeezing more efficiency and profitability out of the footprint we already have. When it comes to component repair, we look for added volume and wider margins as we bring the Product Support acquisition together and capture its synergies. Turning to integrated solutions, while fresh government awards in FY '25 probably wouldn't start until FY '26, our opportunity pipeline is still robust, and we remain in a strong position to serve the DoD's desire to bring commercial best practices to bear in supporting the government fleet. Looking ahead to the first quarter of fiscal 2025, our projections show revenue increasing somewhere between 15% and 19%, alongside an adjusted operating margin around 9%. During Investor Day last year, we laid out both a strategy and a vision, and throughout FY '24 we made enormous strides in delivering against those goals. We've kept growing our leading position in Parts Supply, started construction on airframe maintenance expansions, brought TRAX into the fold, finished the big ever acquisition, and achieved stronger margins by investing in efficiency and distinctive capabilities. That leaves us in an outstanding position to take advantage of the momentum we're witnessing across our markets, and I couldn't be more enthusiastic about what lies ahead. With that said, I'll hand things over to the operator so we can take your questions.

So regarding that final point you mentioned—9% margins—is seasonality the main factor pushing that lower compared to the prior quarter? What are the factors causing margins to decline sequentially from last quarter?

Yes, precisely. Seasonality is the reason. Although seasonality within the business is far less pronounced than in prior years, we do still see some of it since the aircraft we're servicing and component volumes drop somewhat over the summer, as the airlines keep their planes in operation—though it's a good year-over-year gain, I mean, Q1 last year came in at 7.3%. And clearly, we're projecting 9% for this year.

Understood. Then regarding the organic targets, I suppose — I'm not sure if I'm — it's been a lengthy day. I'm somewhat puzzled, because you have margin expansion, yet the EPS CAGR stays the same. Presumably, there's greater interest expense near term. You're going to delever — I suppose I'm just — I'm attempting to square these organic targets here. What is my real starting point, since you had 1 quarter of Triumph, but annualized, if I pro forma that for '24, I can get — I can arrive at a $6 figure at your midpoint in 3 years, or I can arrive at taking the $3.33 and get to something lower. So how should we read these targets?

I would read it as the entire curve has moved upward, meaning we're using the same organic growth assumptions on a higher base that includes Triumph. Yes, we do expect that.

So could I essentially take that $280 million on an annualized basis, which lands nearest for '24, more or less, at those margins, and base my assumptions on that figure?

Correct. Exactly right.

All right. All right. That's useful. So then, the final item I had. Any additional insight on USM — I realize supply is constrained. What's your read in the market out there? It appears this aftermarket, given the troubles at Boeing and Airbus, keeps on delivering gains. Clearly, sourcing any material out there is tough. Still, any shifts in behavior? Anything you can share regarding airline buyers, or simply how things stand in that space?

Yeah, absolutely. I'll approach that from a few angles. To begin with, demand is still incredibly robust across everything we do — maintenance, component repair and, naturally, parts; and you're witnessing tremendous strength from bigger carriers such as United, perhaps somewhat less — still quite strong, though perhaps somewhat less from certain lower-cost carriers, which is what we'd anticipate. Yet on the whole, for our major customers, demand is incredibly robust. You brought up USM. USM, for every one of those reasons, is incredibly, incredibly tight at the moment. Last quarter we truly began splitting that between part sales — sales of individual parts — and sales of whole assets. Part sales, despite everything being incredibly tight, we're performing really well and securing the individual parts that are most in demand, and that produced the 38% growth we recorded in the first quarter for individual parts sales. Whole assets, primarily engines, are getting harder and harder to find. And we've witnessed that market genuinely tighten over the past few quarters, since those assets — those whole engines — head onto wings the moment they're available, which means an operator values them more than folks like us do, given the new engine problems, GTF, and so on. Once more, we anticipate all of that will ease, yet pinpointing precisely when that will happen is very hard.

John, regarding what you said last about the 1Q guidance of 15% to 19% growth, I suppose that points to a bit under that, likely near 4.5% organic versus the 5% to 10% longer-term objective. So how should we view growth for this quarter landing toward the bottom of that range, and the following quarter perhaps falling short of it? What shifts over time to bring you to roughly 7.5% or more?

Right. Several factors. Once more, there's some seasonality during this quarter, and that accounts for part of it. Yet as Triumph Support gets integrated, as we keep seeing supply ease in the U.S. end market, as we scale up the new distribution deals we keep signing, every one of those should keep fueling rising organic growth.

All right. And perhaps, I suppose, only a quick additional question regarding the distribution side — growth there was truly strong. I'd like to mention, the prior quarter came in at 27%, while this one hit 16%. You have the Triumph arrangement, yet my understanding is that won't kick off until a few more quarters pass. So until then, should we simply anticipate double-digit expansion in distribution, and, like, what does that — does the runway exist to sustain that double-digit pace over some stretch?

Yeah. And we expect that to keep going during this fiscal year.

Understood. And after that...

Once more, that involves adding some of those fresh agreements you just brought up, yet it also comes down to — when you look at it from a same-store sales perspective, deals that have been established with us for 12 months owing to the generally robust demand in the market, we keep witnessing solid expansion from our established arrangements too.

All right. And that is — what I mean is, that's primarily over on the commercial side. You brought up possibly moving into < >; and clearly, you've got a government business in this area. Could you break things down in terms of where distribution growth has come from?

Yeah. Excellent question. This quarter we did experience a good return to growth in government distribution. For several quarters that had been declining, and over the last couple of quarters we did observe an inflection point when it comes to bookings and now < > into sales. So given the backlog we hold, we would anticipate government distribution growth to keep going through FY '25. The emphasis on < > along with electronics — those represent fairly new efforts on our part. Some of the early wins we've had on distribution product lines encourage us, and as we expand the sales force and expand our market presence, we would anticipate those becoming contributors; however, I'd see that as more meaningful in kind of '26 and beyond, while the growth in '25 will be more commercial plus a return to growth in government.

Understood. Alright, then only one more from my side for you, Sean. It's quite encouraging to watch net leverage come down as quickly as it did. I believe you've mentioned aiming to reach roughly 2x within the coming 2 years. Does that remain the goal? And what ought we to anticipate regarding deleveraging ahead?

Correct, that's the plan. The objective is to reach that — we had that long-term range of 1 to 2x following the acquisition, concentrating on arriving at that 2x net leverage. And like you said, as I've previously discussed, that roughly 2-year period is a suitable timeline for getting there; yet I'm extremely pleased that in the first quarter we managed to reduce leverage by 3 turns immediately.

John, Sean, I'd like to ask about margins over at Parts Supply. They came in strong this quarter at 13.5%, and the slides referenced favorable mix as well as distribution. So I'm just curious — should that be what we treat as our jumping off point for FY '25? Or ought we to be using some more normalized margin?