AAR Corp. (AIR) Earnings Call Transcript & Summary

Alright, thanks, and I appreciate all of you taking the time this afternoon to go over what we achieved in the latest quarter. The results we posted in the first quarter of fiscal 2025 make us quite proud. It was a strong way to begin the year, and I want to thank our team for pushing forward with AAR's advanced strategic initiatives and for executing consistently across the entire company. Structural tailwinds are working in our favor — high levels of air travel and an aging fleet — and that fuels demand for our aftermarket services. Our organization is more dialed in than ever across our 3 main operating segments: Parts Supply, Repair & Engineering and Integrated Solutions. In all 3 of these segments, we're putting capital to work to generate growth, boost our efficiency and produce better margins. That showed up this quarter, and we anticipate the payoff from these investments will carry through the rest of our fiscal 2025. With that said, let me move on to the first quarter results. Sales for the quarter came in at $662 million, a 20% increase year-over-year, powered by growth in every one of our segments. On top of that, we saw growth in our commercial business and our government business, with each of them up 20%. Our distribution and hangar activities performed especially well, and our recent acquisitions of TRAX and Product Support also added meaningfully this quarter. Turning to profitability, I'm happy that we once again showed substantial operating margin expansion. Adjusted operating margins rose 180 basis points year-over-year, moving from 7.3% to 9.1%; that came from continued organic margin expansion along with the contribution from the TRAX and Product Support acquisition. Now I'll walk through these results in somewhat more detail for each of our 3 main segments. Parts Supply is our biggest and most profitable segment, and it's where we have very substantial room for organic growth. Within this segment there are 2 activities, new parts distribution and used serviceable material, or USM. Distribution accounts for nearly 60% of parts supply and 22% of consolidated sales. USM makes up approximately 40% of parts supply and 15% of consolidated sales; in new parts distribution, sales rose 26% organically, fueled by ongoing market share gains. We gained from both sustained strength in commercial demand and a rebound in our government volumes; we're the largest independent distributor of OEM parts and our independent status is a key strategic advantage, which removes conflicts and lets our OEM partners serve all aircraft types. That's a key driver behind our consistent market share gains, and we think we have a long runway ahead of us given a strong pipeline of opportunities. For the USM activity within Parts Supply, we saw a decline in year-over-year sales driven entirely by the lack of whole assets, predominantly engines available in the market. The drop in whole asset sales comes from what's happening right now in the aviation aftermarket: new aircraft deliveries keep getting pushed back, and there are persistent issues with new engine platforms, so the existing fleet is being used more, and that has led to fewer retirements. On the whole, that's a positive for AAR, but when it comes to USM in particular, it translates into tighter supply; we do expect additional aircraft retirements down the road, and that will bring more USM supply to meet that demand. Moving on to Repair & Engineering. Sales growth for the quarter was 58%. If you set aside the product support acquisition, sales growth was 6%, reflecting continued strong underlying demand for our MRO services. Our hangars are mostly at capacity, yet we keep growing within our current footprint through both better efficiency and improved throughput; that said, our hangar capacity expansions in Miami and Oklahoma City are still on schedule to begin operation in the second half of calendar 2025. As a reminder, those expansions will contribute roughly $60 million of annual sales. On the Triumph Product Support acquisition, the business has beaten our initial expectations across the first 2 quarters, and we're in the early stages of unlocking substantial additional value. On cost synergy, we remain on track to hit the previously announced target of $10 million and are confident we'll surpass that figure once the complete consolidation of our — once we finish consolidating our existing Long Island facility into the facilities in Grand Prairie, Texas and Wellington, Kansas. In addition, we keep making progress on in-sourcing repair work to support our commercial programs and USM activities. Moving on to Integrated Solutions. During the quarter, we generated growth across both our commercial and government offerings. which produced total sales growth of 8% for this segment. TRAX had an especially strong quarter, with some major new business wins and customer implementations. Customer interest in TRAX's offering remains strong, and we're excited about the potential to keep winning market share with new customers and expand our services with existing customers. Our government program activities in Integrated Solutions also had a strong quarter. After the quarter ended, we had 2 significant business wins in government programs. We were awarded a 5-year firm fixed price IDIQ contract with the Navy to perform airframe maintenance on their P-8 fleet. This award is a continuation of existing work; we also won a new contract to support the engine maintenance for the Navy on the same P-8 aircraft fleet; these wins demonstrate the significant value proposition that AAR brings to its government customers. Overall, I'm incredibly proud of the quarter that we just delivered and with that I will turn it over to Sean.

Thanks, John. For the quarter, total sales rose 20% to reach $662 million. If you set aside the effect of the Product Support business we recently acquired, organic sales were up 6% for the quarter. Commercial sales climbed 20%, with each of our 3 core segments contributing growth. Commercial distribution sales stood out in particular, since we keep pushing sales growth on product lines that already exist while also expanding product lines we newly won. Government sales were up 20% as well, which is better than the 15% growth we saw in the fourth quarter. Higher order volume in our new parts and distribution operations, combined with ongoing recovery in government program activities, drove the sales increase. Our adjusted operating profit margin improved 180 basis points, climbing from 7.3% to 9.1%. Adjusted EBITDA margin also gained 180 basis points, rising from 9.5% to 11.3%. As our mix continues shifting toward higher-margin segments and we capture synergies from the recently acquired product support business, we have a clear road map for further margin improvement over the medium term. Our airframe maintenance efficiency improvement initiatives continue to be rolled out, and we expect additional margin gains once capacity expansion projects come online. Our quarterly net interest expense totaled $18.3 million, a figure driven by how we financed the Product Support acquisition, and when it comes to Q2, interest expense should land at about the same level we saw in Q1. On the diluted share count, the average for the quarter stood at 35.6 million shares; looking at FY '25, our expectation for the effective tax rate remains right around 28%. As for adjusted diluted EPS, it climbed to $0.85 from $0.78, which speaks to the gains we're seeing from growth and margin expansion. During the quarter, the Product Support acquisition added to earnings, and we anticipate that will remain the case throughout FY '25. Having said that, let me move on to the segment-by-segment results in detail. In Parts Supply, revenue rose 5%, reaching $250 million. That came from a 26% increase in distribution, offset by a 22% drop in USM. Distribution again delivered double-digit gains as we keep taking share. Several factors lifted growth this quarter: we broadened current product lines, new business wins continued to ramp, and both the U.S. government and foreign governments bought more. Our USM business declined because whole assets were hard to come by. For the quarter, Parts Supply adjusted operating margins climbed 110 basis points to 12.1%, with distribution — helped by scale and mix — driving that improvement. Better margins also came from stronger distribution revenue among government accounts. Our Repair & Engineering segment posted a 58% sales jump, reaching $218 million. Organically, that was up 6%. We're still seeing solid demand for heavy maintenance and component repair work, and we intend to keep growing those areas. Adjusted operating margins for Repair & Engineering rose 460 basis points in the quarter, hitting 11.2%, helped by the product support acquisition and ongoing efficiency improvements in the hangars. Looking ahead, within this segment we anticipate generating additional margin improvement thanks to product support synergies being realized, the paperless hangar programs being rolled out, and the capacity expansions as soon as they become operational in FY 2026. Sales for Integrated Solutions rose 8%, reaching $169 million, fueled by expansion in commercial power-by-the-hour operations, select government programs, and TRAX. For the quarter, Integrated Solutions adjusted operating margin fell 40 basis points, landing at 6.2%, reflecting the mix among government programs; over in Expeditionary Services, our government client has chosen to go back to the current generation pallets, and because of that, our contract to supply next-generation pallets was terminated; we hold the incumbent position on the current generation pallets and will keep meeting the government's need for these products while we wait for a possible new RFP covering the next-generation pallets; we anticipate no material shift in the Expeditionary Services outlook stemming from the government's choice; nonetheless, in connection with the termination during the quarter, we booked revenue of $9.5 million along with a net loss of $3.2 million, both of which sit outside our adjusted results. Now on to consolidated cash. Operating activities consumed $19 million of cash in the quarter, reflecting investments we made in the business, especially inventory, to back the growth in distribution. Even with that cash usage, our net leverage stood at 3.3x net debt to adjusted pro forma EBITDA. Through the remainder of the fiscal year, we intend to bring net leverage down via both EBITDA growth and a decrease in net debt. Thanks to our balance sheet and capital structure, we have ample flexibility to run our business and make choices that maximize shareholder value. With that, I'll hand the call back to John.

Thanks a lot, Sean. The results we posted for Q1 have me quite happy, and it's been a solid beginning to our fiscal year. Our services are still seeing remarkably robust demand, and overall the present conditions across the Aviation supply chain are working to our advantage. As for Q2 of fiscal 2025 in particular, we're looking for sales to grow between 18% and 22%, with adjusted operating margin comparable to what Q1 produced, which came in at 9.1%; we keep making enormous strides when it comes to carrying out our long-range goals. We're still picking up market share and distribution, we remain on schedule for capacity expansions within Repair & Engineering, we're expanding the TRAX software offering and pushing margins upward via investments in efficiency and differentiated capabilities; we are positioned exceptionally well to take advantage of the strength we're witnessing in our markets, and our future has me tremendously excited; so with that, I'll hand things over to the operator for questions.

John, about that Triumph Product Support asset — it arrived with 6,000 proprietary DER repairs. What I'd like to know is how we ought to view expansion in the count of DER repairs you're able to perform, the ones you'll be adding? Or is an annual growth rate the right frame, or simply a figure for repairs you intend to add each year?

Excellent question, and it's a significant asset that arrived through the acquisition. What I'd say is that instead of attempting to put a number on the kinds of repairs, most of those 6,000 DER repairs belonging to Triumph center on structures. Our aim is to widen that DER repair capability into accessories and components repaired across the remaining areas of Triumph, of TPS; so once more, instead of attempting to put a number on a growth rate or a repair count, I'd say that by product type, we'd seek to seize the opportunity past what they've achieved in the structures space.

All right, understood. And I'd like to stay on Repair & Engineering as well. I'm thinking specifically about that MRO hangar. You've got capacity expansions in Oklahoma City and Miami scheduled to come online by fall of 2025, but my question is whether you have enough workers lined up to staff those hangars from day 1. Or will it require time for training, recruiting, and bringing new employees up to speed before you can start generating sales and profits?

Yes. That's a great question, and we're really enthusiastic about this capacity becoming available. We're equally enthusiastic that it's already sold, and we deliberately entered markets where we were confident there'd be a long-term baseload customer and, as you noted, where we'd be able to staff up. Both Miami and Oklahoma City offer favorable labor conditions for us, and we've maintained a presence in each for quite a while. We have ties with nearby providers and schools, among others, so we're quite confident in our capacity to attract talent at both sites. Each facility will experience a ramp-up — that's always the case. There's simply a slight operational learning curve involved, yet we're highly confident that we can achieve a fairly quick ramp up in our ability to bring on the labor needed to serve that new business.

John, regarding USM and the difficulties in that area — how are you folks approaching, or perhaps projecting, sales of whole assets for this year? I have to assume that's tough. And considering the situation with the Boeing strike — clearly, it's hard to predict how long that will go on, but presumably airlines aren't receiving the planes they require. Could that market become even more constrained for you?

Yes. Excellent question. To start, I'd note that even with the downturn we experienced in the U.S. business, we're genuinely pleased that the remainder of the company did extremely well, and we managed to achieve 20% growth during the quarter. That's among the reasons we highlighted it. USM represents 15% of our business; and as you mentioned, yes, anything adding more strain on the current fleet, such as the Boeing strike, will prolong the tight conditions in the USM market, yet more significantly, it will prolong the strong demand we observe for the other 80-plus percent of the company. So we — forecasting this is genuinely hard. And we do anticipate that eventually, as these aircraft get retired and taken apart, that will lead to greater asset availability, and that will happen while demand for these assets remains strong, and we're positioned well to seize that; however, at present, the general tailwinds and dynamics you outlined or that we're witnessing in the market are helping the company overall as a whole.

Understood. Can we somehow separate the revenue from piece parts or components at USM from the drag that was perhaps hidden by those entire asset divestitures, or possibly the growth underneath?

Yeah. Yeah. I'd put it this way: when it came to sales of individual piece parts, Q4 was our best quarter ever at USM. The quarter that just closed ranked second highest we've ever recorded. So sales of individual parts in that business are quite robust, and we can find that inventory. What's limited at the moment are the complete assets. One more point I'd make is that this market is highly situational, correct? That is, you might observe, as happened a couple of years back when American Airlines chose to retire a particular fleet, that circumstances suddenly shift, and our task is to ensure we're positioned properly at the proper moment so we can act swiftly and secure assets as they come up for sale, even absent a broader market shift, and that's precisely what we're concentrating on.

Understood. Understood. And while we're on this call, I mean, how would you describe the current landscape? Is it simply a case of very few assets being out there? Or might you be observing airline operators who want to purchase equipment not for the sake of generating an ROI, but because they have to keep their planes in service. I mean, are you witnessing a significant amount of — yes, please continue.

Yes. No, it's mainly the second scenario. You're seeing airlines — what they really require is the lift. So when assets come onto the market, the carriers themselves or the lessors move quickly to secure those assets, since lease rates are incredibly attractive at the moment, driven by this enormous demand, because the airlines simply must have the lift.

Understood.

One additional thing worth noting is that while those engines are running, a significant amount of green time gets consumed all at once. So when they eventually come in for servicing, a large quantity of components will be needed — and that, once again, creates a positive demand backdrop for us.

Understood, absolutely, certainly. First, Sean, regarding the quarter's adjustments — could you share anything about the investigation costs, which came to $0.14, and the contract termination cost of $0.09? Any details you're able to give?

There's nothing more I can say about the investigation. That same line item has appeared for several quarters now. As for the contract termination, it relates to the Expeditionary Services pallet contracts, which I mentioned during the opening remarks — those are the relevant items.

John and Sean — maybe, John, I'd like to begin with the P-8. From what I hear, the airframe IDIQ largely represents an extension of the effort you already have underway, yet I just want to make sure there isn't possibly some increase there when it comes to the revenue opportunity. Then, second, and I'd say more significantly, regarding the engine side, could you address what portion of that might be incremental in revenue terms during this year, and how it ramps in? And what precisely are you performing when it comes to the engine side? Is it largely parts support? Or perhaps a bit more detail there, please?

Yes. Great. I'm grateful you brought up those 2 awards. So yes, regarding the first, the airframe award, that represents an extension of the effort we currently have. The heavy maintenance volumes for that fleet do shift as time passes; and there's a possibility that we see additional volume from that contract during this next phase relative to what we saw in the prior phase. We need to wait to lock in the award and obtain the schedule from the Navy. But according to what our submitted proposal stated, it's possible a step up in volume could be seen there. When it comes to the engine award, that is completely new business for AAR, and what we'll be doing involves helping to manage the supply chain and provide parts; we have a partner that will actually handle the rents turning. That will emerge once the government releases additional information, but we will be working with that partner to manage the overall engine flow and then supply parts to that partner in support of the engine overhauls.

Is it possible at this point to put a number on how much expansion the engine and the parts supply portion of that agreement might deliver during this year?

As soon as the government gives us complete certainty regarding where we stand on the contract, we will be in a position to share additional figures about that; nonetheless, our feeling is that it will be a solid addition when it comes to both revenue and income, and as for the timing of its start, clearly, we need to determine whether there is a process and so on; even so, our sense is that it will contribute in a significant way.

All right, that's great. Now when we turn to the Parts Supply segment, the margins were strong this quarter — how should we be thinking about how that moves forward? I mean, does a bigger jump really have to wait until you're seeing perhaps a more substantial whole asset chance in USM? Or could there be a way, via mix and via efficiencies, to keep pushing margins on parts supply gradually upward as we consider how this year unfolds and even heading into fiscal '26.

Sure. When it comes to USM, once again, it's kind of situational and hinges on what material is available and what price we can buy it at and then sell it for; so that shifts along with the market. What we are seeing is simply ongoing momentum from our new parts distribution business. Margins in that area, thanks to our exclusive distribution model, are stronger than what a parts distribution business would typically deliver. And with every new win, we can keep leveraging our fixed cost base. So I'd say, as time goes on, we see margin and parts supply improving on a steady basis, driven by growth in distribution, and then, I'd say, on a more situational basis, depending on what opportunities we find in USM.