AAR Corp. (AIR) Earnings Call Transcript & Summary

Thanks. Good afternoon, all, and thanks for joining AAR's Q2 FY2025 earnings call. With us today are John Holmes, our Chairman, President, and Chief Executive Officer, along with Sean Gillan, our Chief Financial Officer. Before we get started, please keep in mind that what we say on this call might contain forward-looking statements, as defined under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements carry risks and uncertainties, and actual results could differ materially from those forward-looking statements. As a result, they aren't a guarantee of future performance.

The company addresses these risks and uncertainties in its earnings release, along with the risk factors portion of its annual report on Form 10-K covering the fiscal year that closed May 31, 2024. While offering forward-looking statements, the company takes on no duty to supply updates reflecting future circumstances or events that may or may not be anticipated. During today's call, certain non-GAAP financial information will be covered. You can find a reconciliation of those non-GAAP measures against the closest comparable GAAP measures in the company's earnings release. Right now, I'd like to hand the call over to AAR's Chairman, President, and CEO, John Holmes. Thanks, and welcome everyone to our second quarter fiscal year 2025 earnings call. I'm glad to report that we delivered another solid quarter, and for Q2 we set a new record on the top line. Our second-quarter sales came to $686 million, which is up 26% from the equivalent quarter a year ago. On an adjusted basis, earnings were $0.90 per share, an 11% increase versus the same period last year, and that also represented a record for adjusted EPS in a second quarter. Both our commercial and government businesses saw sales rise by double digits, and these results make clear how robust demand is for our aftermarket aircraft and engine services. We're very proud of what we achieved during the quarter that just ended, and we're feeling even more optimistic about the remainder of fiscal year 2025 and what lies beyond. AAR continues to generate value across the entire organization, with our focus centered on growing the aftermarket services we provide while working hard to improve margins via portfolio optimization, efficiency gains at scale, and synergies tied to acquisitions. On top of that, we continue to gain from a healthy aviation aftermarket, driven by high levels of passenger air travel, an aging fleet, and growing demand from the government side of the market. This robust demand shows no sign of easing, and we anticipate it will carry on through calendar year 2025. As I noted, our quarterly sales came in at $686 million, a 26% increase compared with the same period a year earlier. In addition, organic sales growth rose, moving up from 6% in the prior quarter to 12% in this one. Each of our three core business segments played a part in that growth. Parts distribution continues to be our biggest revenue category, driven by robust appetite for new as well as pre-owned components. Over the past twelve months, sales rose 20%, all of it coming organically. Our repair and engineering unit expanded 57% versus the prior quarter, thanks to the product support contribution along with sustained strong demand across our hangars. Integrated solutions likewise delivered growth during the quarter. On a consolidated basis, commercial customer sales climbed 30% compared with the same quarter a year ago, while government customer sales were up 16%. Even as top-line growth sped up relative to last year's comparable period, we also showed better bottom-line performance. Adjusted EBITDA reached $78.3 million, a 42% increase over the equivalent quarter last year. On the EBITDA side, the margin moved up to 11.4% this year, compared with 10.1% in last year's second quarter. Adjusted operating margin likewise climbed, reaching 9.2% this year versus 8.1% a year ago. Let me now take a closer look at each of the three main segments. Parts supply continued to be our largest business unit, accounting for just under 40% of total company sales. This segment has benefited a great deal from the strong aftermarket trends I mentioned earlier — including solid demand for engine maintenance, given that engine parts, or engine accessories, make up 60% of what we sell in parts. Revenue for Q2 reached $274 million, which was 20% higher than the same quarter last year and up 10% from the prior quarter. During Q2, part supply's EBITDA came in at $33.9 million, representing a 13% increase over the same quarter last year. Adjusted operating income was $31.6 million, up 11% versus the prior-year period. Within part supply, distribution continued to deliver excellent results. As we've discussed before, our independent distribution model and focus on exclusive agreements have allowed us to secure new business, including a multi-year deal with Wipany, a TransDigm company, which we announced this quarter; we're excited about this win and have many more prospects in the pipeline. In the quarter, our USM operation also returned to growth, driven by sales of piece parts and entire assets. We're seeing more whole assets become available in the market, and combined with demand that remains strong, that should drive further expansion in USM. Engine-related products account for 60% of our part supply sales, as mentioned earlier. The service engine aftermarket has always been a core part of our business. Our partnership with Eftai to supply CFM56 and new materials to the aftermarket is one example of that. Beyond that, we continue to see opportunities for growth tied to engines, such as the exclusive distribution agreement we recently announced with Chromalloy to sell their PMA parts for the CF6 to 80C2 engine type. This deal strengthens the range of engine components we can offer, and it demonstrates how much worth we bring to suppliers as well as customers. Moving on now to repair and engineering. In Q2, revenue hit $229 million, which is 57% higher than the same quarter last year. Adjusted EBITDA rose to $30.9 million, a 132% gain versus the comparable quarter a year earlier, and adjusted operating income came in at $27.4 million, which is 143% above the prior-year period. The product support acquisition continues to deliver excellent results and is driving expansion in the repair and engineering segment. Integration is proceeding according to plan, and we remain on course to realize the $10 million in cost synergies we previously discussed. We expect to finish bringing everything together during the first quarter of fiscal 2026, and that's the point where we think synergies will be fully reflected in our run rate. While that integration work is happening, we're growing the business too — you can see that in the joint venture we announced not long ago with Air France, covering engineering and maintenance support for next-generation aircraft in Asia Pacific. When it comes to repair and engineering on the heavy maintenance side, demand for what we offer continues to look healthy, and our priority stays on rolling out process improvements that steadily lift efficiency and push more volume through the facilities we already have. Right now, we're in the middle of adding hangar capacity in Miami and Oklahoma City. When those finish in FY26, it'll take another one or two quarters of ramp-up before we hit that $60 million in additional yearly revenue for the company. Now shifting to Integrated Solutions. Quarterly sales came in at $163 million, which is a 4% increase versus the same period a year ago. Adjusted EBITDA for Integrated Solutions in Q2 was $12.3 million, a bit down compared to last year's same quarter. Adjusted operating income reached $8.3 million, which was 8% below the prior-year quarter, driven by mix shift within certain programs. Looking ahead, we anticipate growth will pick up as our government program activities turn their pipeline of opportunities into new business wins and as our recent contract wins mature. Take, for instance, a fresh piece of government business we just landed: the US DOD tapped us for engine overhaul services supporting the Navy's P-8 fleet. Demand requirements are still being nailed down alongside the government, though we anticipate low single-digit millions each quarter to start, before climbing to a much bigger level later in FY26. Beyond that, our position is exceptionally strong when it comes to assisting the new administration in hitting its efficiency targets — be it via the DOD, commission, or any other route.

Through what we provide, agencies we serve in the public sector can lower their expenses and still achieve better or equal results. We're eager to keep showing what we can do for the US Department of Defense, the State Department, and additional agencies. Before I hand things to Sean, I want to quickly cover 2 items we announced just ahead of the holiday period. To start, on December 19, we shared that we had arrived at resolutions with the Department of Justice and the Securities Exchange Commission concerning potential violations of the Foreign Corrupt Practices Act that we had previously disclosed. This pertains to specific transactions signed during 2016 and 2017 in Nepal and South Africa. Following self-reporting to the government in 2019 and our cooperation across a multi-year investigation, AAR has signed a non-prosecution agreement with the DOJ and come to a resolution with the SEC. The settlement carries a total figure of $55.6 million. This has been a drawn-out effort; we're glad the matter is finally resolved, and I take pride in how our company handled it. Over the past several years, we've poured substantial investments and enhancements into our compliance program. In a separate development, on December 20, we said we had signed a definitive agreement to divest our landing gear overhaul business to GA Telesis for $51 million. We made this strategic choice to sharpen our focus even further on aftermarket activities that deliver higher growth and higher margin. It also frees us to direct still more resources toward an integrated approach linking product support, heavy maintenance, and part supply, an area where we see considerable revenue synergy opportunities. We anticipate the landing gear deal will close during the first calendar quarter of 2025, and at closing it will be immediately accretive to margins and earnings. We're grateful for all the effort and commitment shown by our landing gear team, and we wish them and GA Telesis great success going forward. I'll hand it to Sean now so he can walk through our Q2 results in greater detail.

Appreciate that, John. For the quarter, total sales rose 26% to $686 million, which marks a new quarterly sales record for the company. If you set aside the contribution from the product support business we acquired recently, organic sales growth came in at 12% for the quarter, up from the 6% organic growth rate we posted last quarter. Promotion sales were up 30% in the quarter versus 20% in the prior quarter. That extra lift in sales growth was broad-based across all three of our core business segments, with commercial distribution and product support sales leading the way. Government sales rose 16% as well in the quarter, mostly on higher order volume and new parts distribution. Commercial sales overall accounted for 73% of total sales in the quarter, with government sales making up the other 27%. Against the same quarter a year ago, adjusted EBITDA margin went from 10.1% to 11.4%. Adjusted operating profit margin went from 8.1% to 9.2%. Our emphasis on airframe maintenance efficiencies, plus the contribution from the product support business we acquired recently, has helped us deliver a meaningful improvement in margin performance. Net interest expense came to $18.8 million for the quarter, which reflects the financing of the product support acquisition. We anticipate Q3 net interest expense will stay in line with these levels. We also anticipate our Q3 effective tax rate will be roughly 27%. The average diluted share count for the quarter was 35.5 million shares. Adjusted diluted EPS went from $0.81 to $0.90, which reflects the benefit of our growth and margin expansion. With that, let me move to the detailed results by segment. Part supply sales climbed 20% to $274 million, helped by growth in both distribution and USM. Higher commercial volume fueled growth in both businesses, together with an uptick in government demand for new parts distribution. Part supply adjusted EBITDA margin went from 13.2% to 12.4%, and adjusted operating margin went from 12.5% to 11.5% in the quarter, which stemmed from whole asset sales at lower margins in the same period. Repair and engineering sales rose 57% to $229 million. On an organic basis, sales were up 6%. Demand remains strong for our heavy maintenance and component repair capabilities, and we aim to keep driving growth in these activities. Repair and engineering adjusted EBITDA increased from 9.1%, and EBITDA margin increased from 9.1% to 13.5%. Adjusted operating margin rose from 7.8% to 12% in the quarter, driven by the product support business and continued efficiency gains in the hangars. Looking ahead, we expect to drive further margin expansion in the segment from the realization of product support synergies, continued roll-off of our paperless hangar initiative, and the capacity expansion once they come online in FY26. Integrated Solutions sales rose 4% to $163 million, driven by growth in commercial activities. Integrated Solutions adjusted operating margin and adjusted EBITDA margins decreased slightly to 5.1% and 7.5%, respectively, in the quarter. Turning to consolidated cash. Cash flow generated from operating activities was $22 million in the quarter. The cash we produced, combined with growth in EBITDA, brought our net debt leverage down from 3.3 times to 3.17 times over the quarter. Back in March of last year, when we completed the product support acquisition, net leverage stood at 3.6 times, and we stated that we anticipated returning to roughly 2 times net leverage within two years. We remain on track to hit that goal, since we expect to keep delevering through the rest of this year and on into next year. Now I want to talk about how the two announcements we made recently affect us financially. To begin with the FCPA resolution: the settlement figure of $55.6 million was recorded in the fiscal Q2 results we're reviewing today. That settlement has already been paid, and it will show up in our third-quarter cash flows. We funded that payment by drawing on both cash on hand and our revolving credit facility. Turning to the second item, the landing gear overhaul business, we expect this transaction to close in the first quarter of calendar year 2025. Should it close by the end of February, we'll get a cash payment of $51 million, net of applicable fees and expenses, in our Q3 results. As the press release noted, once this transaction closes, the benefit will be immediately accretive to earnings and margins. Alongside our decision to divest the business, we expect to recognize a non-cash pre-tax loss of approximately $60 million, which will appear in our Q3 results. Looking ahead, we anticipate that the size of our adjustments between our GAAP results and our adjusted non-GAAP results will be significantly smaller. Across the next few quarters, our acquisition and integration-related costs will wind down as the contingent consideration, retention, and related integration costs are fully recognized. On the divestiture side, we would anticipate that the exit costs tied to our landing gear overhaul and composites businesses will also wind down by mid-fiscal 2026. At that point, we would expect our ongoing non-GAAP adjustments to consist largely of acquisition intangible asset amortization, of approximately $4 million per quarter. With that, I'll hand the call back over to John.

Alright, thanks, Sean. I'm really happy with what we delivered in the second quarter and the momentum that has carried forward since this fiscal year started. When it comes to the rest of this fiscal year, and Q3 in particular, our expectation is sales growth of 22% to 25% compared with the prior year, along with an adjusted operating margin between 9.2% and 9.4%. Looking toward the remainder of this fiscal year and on into the next one, we anticipate demand for our services staying robust. Commercial aviation's broader macro backdrop continues to be quite strong. On top of that, we have several levers available to keep generating meaningful growth. Bookings are solid, new distribution contracts are ramping up, and we're seeing additional assets become available that will fuel expansion in our USM activity. Over in repair and engineering, growth in the coming fiscal year should be supported by the two hangar expansions, while our worldwide sales organization will produce incremental gains throughout the product support business we recently acquired. Then, within integrated solutions, we have a robust pipeline of fresh opportunities spanning our government and commercial offerings, tracks included. On the profitability side, we keep making enormous strides toward fulfilling our long-term goals. The progress achieved so far makes me extremely proud. Our adjusted operating margins have risen to 9.2% today from 5.5% before COVID, and we anticipate further improvement. Going forward, margin expansion will mainly stem from three places: First, capturing synergies from the product support acquisition we recently completed. As I noted before, we expect to reach that $10 million run-rate synergy during Q1 of the upcoming fiscal year. Beyond that, pushing more volume through the product support site should bring about additional margin expansion. Second, our heavy maintenance hangar network. The new capacity set to come online in the next fiscal year won't just fuel growth — it will also lift operating margins, since we'll be leveraging the cost structure already in place to satisfy higher demand. On top of that, within the hangars, we anticipate better efficiencies resulting from a number of digital initiatives we've invested in over the past several years. The third source will be a mix benefit as we grow our part supply segment. We keep seeing substantial opportunity in distribution, which our solid pipeline of OEM contracts and recent wins make clear. Once these new distribution agreements mature, we expect further margin expansion. Worth noting: the exclusive contract approach in our distribution business lets us capture better margins than traditional distribution models, thanks to the extra value we deliver to suppliers and customers alike. And we'll keep working to bring our leverage down. Before I hand things to the operator for questions, I want to thank our committed employees, our customers, and our shareholders for the ongoing interest in and support of AAR. With that, let's open the line for questions.

Evening, John and Sean. You brought up the fresh distribution deal you've struck with Chromalloy covering PMA parts for the CF6 engine. Over on the CFM56 and V2500, Chromalloy also makes some PMAs for Eftai. Could any restrictions stand in the way of you distributing those PMA parts for those engines? And if that's the case, might some kind of arrangement be reached involving Eftai and Chromalloy so that you'd be allowed to distribute those PMAs for the CFM56 and V2500?

Well, thanks for asking that. What I'd tell you is that we know the PMA portfolio Chromalloy holds quite well. And, clearly, there's a joint venture we have with Eftai, plus now a long-term relationship with Chromalloy. We're in a number of other conversations with both of them as partners we already have, and all three of us are constantly searching for ways to expand the business together.

All right. Then I have one more thing to ask about the wider market as well as the commercial aftermarket. Many people are asking whether certain budget airlines in the US can survive over the long haul. So I'd like to know if you could quantify how much of your revenue comes from those ultra-low-cost carriers.

Yes. That's a terrific question; the bigger airlines make up a very disproportionate share for us. United Airlines, Delta Airlines, American, and so on are our biggest customers. So although we do conduct a bit of business with the cheaper carriers, within North America that represents only a tiny portion of what we do.

Understood, that makes sense. And then a fast one for Sean. Sean, in case you've got that available, could you share what the organic growth figures were for commercial and for government?

Nope. That isn't something I have on hand. What I'd say is you can derive it by looking at inorganic growth, which, as you know, originated with TPS, and the bulk of that is commercial work; so I can assist you in arriving at an approximate figure, but breaking out organic growth based on usual activities isn't something we disclose.

All right, understood. Thanks for taking the questions.

Hi there. Good afternoon, John and Sean.

Hi, Ken.

Hi, John. You brought up expansion in Q2 within your USM portfolio. Could you put some numbers behind that, and perhaps discuss where exactly you're observing it across the entire asset side? Also, how ought we to think about it for the back half of the fiscal year—is it picking up speed, staying flat, and what kind of upside might it deliver in that period?

Let's see here. We don't provide separate figures for USM growth. What I can tell you, though, is that it definitely sped up between Q1 and Q2. Growth is indeed happening in USM. When it comes to assets up for sale, far more are appearing now compared with three months earlier. Calling it a pattern is difficult since we've only had one quarter of it. Broadly, however, we're engaging in additional discussions and, once again, noticing a greater number of available assets driving expansion this quarter, and we'd anticipate further expansion over the remainder of the fiscal year provided we can secure those assets.

What's the situation with pricing for certain of those assets — say older powerplants such as the CFM56 and V2500? Do you keep observing upward pressure when it comes to pricing? Is there any indication yet that this market might have hit its top? What are you witnessing regarding pricing for a few of those legacy engines?

I would describe pricing and values as remaining extremely robust. I wouldn't characterize them as speeding up at the rates we previously witnessed, yet they remain extremely robust. And naturally, the amounts we shell out for assets — we can demand equally robust pricing in the marketplace so that our spreads are preserved.

All right, that's helpful. So looking back at fiscal 2024, margins in the parts supply segment really stepped up from the first half to the second half. When we map out that same first-half, second-half pattern — I realize you don't break out formal guidance at the segment level — but directionally, how should we frame parts supply margins? And is there anything that would stop us from seeing a comparable build through the back half of the year in that segment's margins?

I don't have last year's margin figures right in front of me, but our expectation is that margins will expand in the back half of our fiscal year compared with the front half. So as we've said, Q3 margins should move higher in Q3. Beyond that, we'd anticipate additional expansion in Q4. That comes from across the whole company, though for parts supply in particular, it's tied to newly signed distribution agreements as they scale — that's where margin expansion typically shows up. As you're aware, we've kept layering win upon win, which creates a compounding impact within the distribution business. And with USM, since more assets are now becoming available to us, we'd look for additional growth there. Predicting USM's margin profile is difficult given how transactional that business is, and because you're working with assets whenever they happen to come available, but broadly speaking, for parts supply we'd anticipate an upward trajectory mostly powered by distribution.

That's great. Thank you, John. I'll hand it back over there.

Excellent. Appreciate it, Ken.

Hello there. Good evening, everyone. Appreciate you taking my question. Great results.

Thanks.

Sean, perhaps to remain on the topic of margins. I believe I caught you mentioning that part supply EBITDA margins declined compared to the prior year. I think you might have pointed to the mix regarding whole asset, yet even with a sequential drop, is there any cause for worry? Any shift in the underlying distribution margins by customer, whether commercial or government, or was it all genuinely tied to whole asset?

No cause for worry; it's mostly attributable to whole asset. Thus, in the prior year, we had whole asset sales carrying a greater margin. In the current year, our whole asset sales carried a reduced margin. That is just how that business works, depending on which whole assets turn up for us and the expense required to acquire those assets; so I wouldn't view that as any kind of trend. The key point to recognize is that while during this year's first quarter, we had found it quite difficult to locate any whole assets to sell, it was encouraging to see assets become available to us that were closed during the quarter, and we possess a far more robust pipeline of assets on hand for us as we move through the remainder of this fiscal year.

That's a strong observation. When it comes to that subject, what's your sense of the cause? Clearly, Boeing and Airbus are still having a hard time and probably won't return to form anytime soon. Or, put another way, what's behind that shift?

Right. Precisely. I wouldn't tie this to higher build rates, other than, once more, I view it as case-by-case. And, as you know, our sourcing group is extremely capable and can locate equipment available in the marketplace. And I think we're performing well, beating rivals and securing those assets before they do. So I wouldn't describe this as a pattern tied to more output from the OEM. My sense is you might be seeing a bit of easing because of certain developments involving the lower-cost carriers and the bigger lessors, their lead portfolios. That said, once more, I'd call it case-by-case at this moment. And we're simply executing a very solid ground game to ensure we're in position when those opportunities come up.

Understood. Then perhaps only one more item, Sean. Could you help establish a baseline for us regarding the R&E margins, so that by around February, you'll have divested the unprofitable landing gear business. Could you give us some calibration for modeling revenue and explain what effect that actually has on margins? I'm not sure whether it's significant enough to shift the needle on the sort of 3 to 5-year margin targets you've provided, but presumably it will provide some benefit.

Yes. I'd describe it as a component of reaching those 3 to 5-year targets when it comes to margin expansion, and what's going to occur in R&E. As John said, it's really going to stem from 2 main sources: the delivery of the synergies tied to the product support acquisition, and completing that is what gets you to that $10 million figure, as John noted, which will occur in our Q1 of the upcoming fiscal year. That's the point when it will be finished and delivered. Then the second element of that is going to come from the hangar expansions. So both of those are, in a sense, in the next fiscal year for that subsequent larger shift in margin; over the nearer term, I think we would anticipate fairly steady performance, perhaps a modest gain, as you said, with landing gear being removed. I should point out that landing gear won't be removed from the results until the deal is closed. Therefore, during our fiscal Q3, it will probably still be in the results and then absent from the Q4 results.

Understood. Okay, thanks, everyone. I'll get back in line again.