AAR Corp. (AIR) Earnings Call Transcript & Summary

Thanks. Hello, everyone, and good afternoon. It's a pleasure to have you join AAR's earnings call for the third quarter of Fiscal Year 2025. With us today are John Holmes, our Chairman, President, and Chief Executive Officer, along with Sean Gillen, our Chief Financial Officer. You can find the presentation material for today's webcast in the Investor Relations section, under the Events and Presentation tab on our corporate website. Before we get started, please note that remarks on this call might contain forward-looking statements, as outlined in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements carry risks and uncertainties that might lead actual results to differ materially from those statements. Therefore, they do not guarantee future performance. The company's earnings release and the risk factor section of the annual report on Form 10-K for the fiscal year ended May 31st, 2024, discuss these risks and uncertainties. When offering forward-looking statements, the company undertakes no obligation to update them for future circumstances or anticipated or unanticipated events. Today's call will include discussion of certain non-GAAP financial information. A reconciliation of these non-GAAP measures to the most comparable GAAP measures appears in the company's earnings release and slides. A transcript of this conference call will be posted on AAR's website shortly after the webcast. Now, I'd like to hand the call over to AAR's Chairman, President, and CEO, John Holmes.

Alright, thank you. Hello everyone, and welcome to our earnings call for the third quarter of fiscal year 2025. I'm happy to share that AAR delivered another robust quarter, with records set for both sales and adjusted EPS. During the quarter just ended, we generated value across the entire company by expanding our aftermarket services and achieving substantial margin gains. Demand remains strong in our commercial and government markets, and we expect that to hold up through calendar year 2025. Now, if you'll turn to slide three, I'd like to walk through a few accomplishments from the quarter. Sales in the third quarter reached $678 million, up 20% compared with a year earlier, marking a new third quarter sales record for AAR. Strength persisted across our business segments: consolidated sales to commercial customers rose 22% versus the same quarter last year, while sales to government customers were up 15%. Even as revenue increased year over year, we also posted meaningful gains on the bottom line. Adjusted EBITDA came in at $81.2 million, an increase of 39% over the same quarter last year. EBITDA margin rose to 12% this year, compared with 10.3% in last year's third quarter, powered by excellent results in our new parts distribution activities and our airframe MRO operations, along with our product support acquisitions. As before, higher sales combined with wider margins produced a sizable lift in adjusted earnings per share, which climbed 16% to $0.99, versus $0.85 in the same period a year ago. In addition, during the quarter just ended, we brought net debt leverage down to 3.06x from 3.17x in the previous quarter. With a strong balance sheet and a disciplined approach to capital allocation, we are well positioned to make investments that keep driving growth. Now moving to slide four, I'll go into greater detail on our three core business segments. Parts supply remains our biggest segment, accounting for close to 40% of total company sales. Third quarter sales of roughly $271 million rose 12% relative to the same quarter last year, mainly on the strength of considerable growth in our new parts distribution activities. For parts supply, third quarter adjusted EBITDA was $36.8 million, up 12% from the same quarter last year. New parts distribution keeps delivering outstanding growth for this segment, with sales up 20% organically over the prior year quarter, showing meaningful gains in both our commercial and government markets. Margins came in better than we expected thanks to a favorable product mix and scaling efficiencies as newly added exclusive distribution contracts continued to ramp. Let me pause here to spotlight our new parts distribution business. That business has achieved organic double-digit growth in each of the last 13 quarters and now accounts for roughly 60% of our parts supply segment. Our position as an independent distributor, paired with our emphasis on exclusive contracts, offers a compelling value proposition to our customers and OEM partners. One illustration we can point to lately involves a deal spanning several years that gives us exclusive distribution rights for certain Unison components, done through the supplier capabilities contract we hold with the Defense Logistics Agency. Through that arrangement, we deepen our reach with Unison, a major supplier, while also assisting the U.S. Government in fulfilling what it requires. On top of that, we signed a multi-year exclusive deal with Chromalloy covering distribution of their PMA parts for the PW4000 engine platform. That follows the agreement we announced earlier regarding distribution of Chromalloy PMA parts for the CF6 to 80C2 engine platform. Within our U.S.M. operations, growth versus the prior year was modest, landing below what we had anticipated for the quarter. Volume dropped because of how engine inductions were timed across certain contracts we serve; we view that softer volume as something temporary. Although engine material and narrowbody assets are still tight, as discussed last quarter, we are noticing indications of easing, with additional whole assets reaching the market. We keep a close watch on this market and feel we are positioned well to put money into parts and whole assets whenever they satisfy our return requirements. Along those lines, the announcement made this morning about extending our CFM56 arrangement with FTAI gives us exclusive access to this highly sought-after material both now and in the years ahead. Shifting to the repair and engineering segment, third quarter sales reached $216 million, representing 53% growth from the same quarter last year. Adjusted EBITDA rose to $27.9 million, an increase of 110% from the same quarter last year. The product support acquisition keeps performing strongly, fueling growth and margin improvement within the repair and engineering segment. As a reminder, through the product support integration, we are shutting down our Long Island, New York, facility and moving that work into our Dallas and Wellington, Kansas, locations. The site integration remains on schedule to wrap up during our fiscal fourth quarter, and we plan to completely exit the New York facility in Q1 FY2026. With that said, we experienced somewhat lower efficiencies and throughput this quarter, since we sharply increased headcount at the two sites taking on the work. Once our new technicians gain more experience, they will be capable of repairing units with greater efficiency. As we move past this especially busy stretch of the integration process, we anticipate our operating efficiency will rise, which backs our plan to keep expanding overall margins. Lastly, it's worth noting that backlog keeps building across our component repair sites as we use our global sales force to secure new business. One case in point is the multi-year agreement announced recently with Cebu Pacific covering CFM56 engine nacelle maintenance for their A320 fleet. This effort is going to take place at our facility in Thailand, and it marks a significant victory in the vital Asia-Pacific area; when it comes to airframe MRO within repair and engineering, we keep witnessing robust underlying need for what we offer and remain committed to rolling out process enhancements that keep boosting efficiency and raising throughput at the sites we already operate. Such measures have proven highly successful and resulted in margins that beat expectations during this quarter. Both of our hangar capacity expansion projects, in Miami and Oklahoma City, are moving forward. The build-out in Oklahoma City is running a bit ahead of plan, while the one in Miami is running a bit behind because of certain permitting holdups. Moving on to integrated solutions, revenue for the quarter came in at $163 million, a touch below the equivalent quarter a year ago because of a net reduction in our government activities overall. Although we experienced a decrease in some current programs, growth in new programs partly made up for it, and we anticipate that trend will persist and fuel overall expansion in upcoming quarters. Adjusted EBITDA for integrated solutions during the second quarter reached $16.2 million, up 11% compared with the same period a year earlier, driven by a mix shift among certain programs and robust results from TRAX. Regarding TRAX, even though it contributes relatively little at present, as we put money into it and grow the offering to win more contracts, TRAX will push additional operating margin growth for the entire company. One illustration of a fresh business win is Cathay Pacific, which just picked TRAX to serve as the new maintenance operating system for its airline. Moreover, we anticipate that TRAX will eventually turn into a sales channel for our parts operations, and we are directing investments toward backing that effort. Before handing things to Sean, I wanted to say something about the present government landscape and DOGE specifically. AAR is capable of delivering major cost reductions to the government by putting our commercial best practices to work; we have already shown this through what we do in supporting the U.S. Navy's P-8 fleet for airframe and engine maintenance. What we provide enables the government to cut expenses and enhance readiness. In addition, we keep chasing USM sales possibilities with the U.S. Government, which offers a money-saving substitute for buying new parts. We are eager to further showcase what we can do for the U.S. Department of Defense, State Department, and other agencies, and we have handed in a paper to the DOGE Commission detailing particular areas in which we are best positioned to deliver cost savings. I will now hand things over to Sean so he can go over our third quarter results in greater depth.

Thanks, John. Turning to slide five now, overall revenue for the quarter rose 20% year-over-year to $678 million, which marked a record for any third quarter. Better availability of parts, thanks to more distribution activity, combined with stronger repair and engineering sales, produced a sizable revenue gain versus the prior-year period. Commercial customer sales were up 22%, while government customer sales rose 15%. During the quarter, commercial sales accounted for 72% of the total, with government making up the other 28%. Versus last year's same quarter, adjusted EBITDA climbed 39% to $81.2 million, and EBITDA margins went from 10.3% to 12%. Adjusted operating income was up 39% to $65.6 million, as adjusted operating margins improved to 9.7% from 8.3%. Our emphasis on airframe maintenance efficiencies, plus the contribution of the recently acquired product support business, keeps helping to lift margin performance. Net interest expense came in at $18.1 million for the quarter, reflecting financing tied to the product support acquisition. For Q4, we anticipate net interest expense staying in line with these levels. We also anticipate our Q4 effective tax rate will be roughly 30%. That higher effective tax rate stems from the impact of the impairment related to the landing gear divestiture. In quarters ahead, we anticipate our effective tax rate will be roughly 28%. Average diluted share count for the quarter was 35.4 million shares. On a year-over-year basis, adjusted diluted EPS rose 16% to $0.99, up from $0.85 in last year's same quarter, reflecting the benefit of our growth and margin expansion. With that, I'll move to the detailed results by segment, beginning with parts supply on slide six. Parts supply sales rose 12% to $271 million versus last year's same quarter, driven by growth in both distribution and USM, with distribution sales beating expectations. Higher commercial volume fueled growth across both distribution and USM, along with a rise in government demand for new parts distribution. Third quarter parts supply adjusted EBITDA was $36.8 million, up 12%, and adjusted EBITDA margins were flat at 13.6% versus last year's same quarter. Adjusted operating income rose 10% to $34.3 million, and adjusted operating margins dipped slightly, from 12.8% to 12.7%. Moving now to slide seven for repair and engineering. Sales rose 53% to $216 million, and demand stayed strong for our airframe MRO and component services capabilities. Adjusted EBITDA of $27.9 million was 110% higher than in last year's same period, while adjusted EBITDA margins rose to 12.9% from 9.4%. Third quarter adjusted operating income of $23.9 million was 108% higher, and adjusted operating margins rose to 11.1% from 8.2% in last year's same period. Looking ahead, we expect to drive further margin expansion in this segment from realizing product support synergies, continued rollout of our paperless hangar initiatives, and the capacity expansions now in process. Turning now to slide eight. Revenue from integrated solutions dipped a bit — down 1.6% to $163 million — as government program sales came in somewhat lower, though that was partly offset by better commercial program sales and gains from TRAX. Adjusted EBITDA for integrated solutions came to $16.2 million, an 11% increase over the prior-year period. Adjusted operating income reached $12.4 million, also up 11%, and adjusted operating margin was 7.6%, a touch higher. As John noted earlier, TRAX continues to deliver strong margins. Moving to slide nine in the deck. In the quarter, we brought net debt leverage down from 3.17x to 3.06x, even with an operating cash use of $19 million stemming from the $56 million FCPA settlement paid during the period. At the time we completed the product support acquisition last March, net leverage stood at 3.58x, and in the year since that close we've made solid headway on deleveraging. Thanks to our strong balance sheet, we're well positioned to invest organically and potentially pursue value-accretive acquisitions. Without any M&A, we'd anticipate continuing to delever toward our target net leverage range of 2x-2.5x. I also want to give you an update on the sale of our landing gear business. We're nearing close and expect the divestiture to wrap up during this quarter. Once it closes, the cash proceeds will go toward debt paydown, which will show up in our fourth quarter cash flows. Our fourth quarter results will reflect landing gear results through the sale's closing date. For context, landing gear contributed $19 million of sales in Q4 of last year and is currently generating roughly $6 million-$7 million of sales per month. With that, I'll hand the call back to John.

Okay. Thanks, Sean. Let's move to slide 10. To sum up, during Q3, solid results in new parts distribution, airframe MRO, and TRAX produced operating margins that beat our expectations, and product support integration is proceeding according to plan. USM results continue to fluctuate because of market conditions, yet the broader company's overall strength lets us speed up our margin expansion work. Regarding Q4 FY2025, we anticipate sales growth versus the prior year in the mid-single digits. This sales growth guidance presumes roughly one month of landing gear revenue will be part of our Q4 financial results. If you set aside the landing gear divestiture's effect, our year-over-year sales growth will land nearer the high single digits; we anticipate adjusted operating margin between 9.7% and 9.9% in Q4. As Sean noted, we also anticipate net interest expense matching Q3's $18 million, and an effective tax rate of about 30% for the quarter. Exactly as we said last quarter, we keep seeing robust demand signals from our biggest commercial and government customers. We anticipate growth and margin expansion continuing this year and through FY2026. Before I hand things to the operator for questions, I want to thank our team of committed employees, our customers, and our shareholders for your ongoing interest in and support of AAR. With that, we'll begin taking questions. Okay. Thanks. Hey, Scott. Scott, are you with us? Okay. Shall we move to the following question? Operator, perhaps we can proceed to the following question?

Yeah. Hey, good afternoon, John, and Sean, and Denise.

Hey, Ken.

Hi John. To start, you mentioned something — once more — about USM, which I believe you described as declining a bit during the quarter, though you also said, I think, that this would prove short-lived. Could you expand a little on what you're observing in that market, and what makes you confident that USM might actually rise in Q4? And then, how should we frame that as we look ahead to fiscal 2026?

We've become fairly comfortable discussing USM. During this quarter, a few situational factors were at play. In the USM operation, as everyone knows, we provide support for the majority of its engine material, plus we back specific engine shops under contract. Some of our customers experienced engine shop inputs that came in below what they had anticipated from their end users, and that led to reduced need for our material on those specific contracts over the quarter. We view this as temporary, since these amounted to maintenance deferrals by their end customers, and we anticipate that work will be completed at a later point, meaning we'll see that demand down the road. Broadly, in line with our comments from last quarter, we're observing additional whole assets and parts packages arriving on the market in USM. When those assets satisfy our return requirements, we're ready to put money into them in places where we identify demand.

Okay. To build on that, there has definitely been increased worry regarding capacity expansion among U.S. carriers at first, and perhaps now a handful in Europe as well. Could you share whether any of that is already affecting your operations? And perhaps, how substantial a decline in capacity would be required before you'd actually begin noticing consequences across various segments of your business?

That's a good question. We're definitely keeping an eye on what the airlines are saying, both here and in Europe and other regions. Broadly, we aren't observing any significant drop in demand signals for what we provide. When it comes to parts supply, airframe heavy maintenance, and component maintenance, demand from our customers across all those services is as strong as it's ever been. Right now, we feel pretty good. Our focus would be to keep, as much as there are capacity reductions, our focus would be to keep showing our value. As much as there's less work coming from the airlines, it will move away from our competitors and stay with us.

Great. Thanks, John. I'll pass it back there.

Great. Thank you, Ken.

Good afternoon to you, John, Sean, and Denise.

Hi there, Louie. How's it going?

Great. Good job on the margin improvement. Investors have been watching that closely. I was curious—you gave us the figure that landing gear, I believe, brings in about $20 million of revenue each quarter. Once that divestiture closes, could it add 30 basis points-40 basis points to the EBITDA margin?

No, nowhere near that. To be clear, landing gear's results were entirely in Q3, and we anticipate closing soon. Our Q4 guidance assumes landing gear is included for one month. On operating profit, it's roughly break-even to slightly positive. Overall, it will be accretive to margins, but not to the degree you mentioned.

All right, great. One more thing. Your TRAX operation secured that agreement with Cathay Pacific, and earlier you'd let everyone know about a win involving Singapore Airlines. As those ramp up, ought they to help push margins higher? And are there additional TRAX arrangements coming down the line, since it appears you've built up steam in that APAC area?

Yeah, yeah, no. Appreciate you bringing that up. Affirmative on both counts. Those should bring additional volume into TRAX, in our expectation. Within this company, TRAX delivers the strongest margin of any business we have. Growing that operation lifts margin overall in an accretive way. When it comes to TRAX, our customer pipeline is quite robust. Not every win is something we're able to make public. Certain clients permit us to share the news publicly. Others do not. Luckily, both Singapore and Cathay were in a position to allow us, or at least willing to allow us, to make those wins known. Whether it's the ones we're able to disclose or the ones we aren't, our confidence in the opportunity pipeline for TRAX is very high.

Fantastic. Appreciate it, John. I'm all set.

Excellent. Thank you, Louie.

Hi there, good afternoon to all of you. You had brought up the higher throughput at MRO facilities, and for some time those have been operating at or close to maximum capacity. That progress is nice to see. Could you discuss the efficiency gains and perhaps how significant an effect that has had on margins? And second, do you anticipate additional room for greater throughput in the near term? Yes. Excellent question. If you look at the past several quarters, we have achieved considerable margin improvements in our airframe hangars. We have also kept growing sales; we take pride in the fact that we have managed to boost margins while labor costs in particular have been inflationary and to increase sales on the same footprint. As you mentioned, that stems from higher throughput.

We also see chances to keep pushing on two fronts: higher throughput and sales growth, plus additional margin gains within the hangars on the footprint we already have over the next few quarters. Take one program as an example — we've brought this up a few times — our paperless effort in the hangars hasn't been completely deployed yet; we've achieved substantial headway over the past few quarters getting it out there. There's still more room to go before that program is fully in place across our whole network. That's going to produce additional margin gains. On top of that, after we finish the build-outs in Oklahoma and Miami, that too will generate additional margin gains, since we'll be spreading our fixed cost base across those newly added bays at both locations.

Perhaps you could give us some news regarding defense possibilities. You mentioned USM components in connection with DOGE. Compared with what things looked like maybe 3 months back, how much more activity are you seeing there? And as we look ahead, at what point might we realistically anticipate those possibilities actually materializing?

That's a really good question, and the timing is right. To start with, yes, that possibility does exist — when it comes to USM sales into the government, we haven't yet observed any meaningful pickup. Should anything develop on that front, it would represent additional upside beyond our current position. In fact, I was in Washington, D.C. just yesterday, where I attended quite a few meetings on the Hill. This opportunity came up in those discussions. It's a concept we've actually been discussing with the government for quite a while now, but with the DOGE Commission now in place, plus the broader climate that favors experimenting with new approaches at scale and moving fast, we hold out hope that this is the point when USM could finally see substantial adoption; the conversations have left us encouraged, and any such uptake would add to what we're delivering now, since as things stand, on the USM side with the U.S. Government, there simply isn't much happening today.

Great. I'll leave it there. Thank you.

Excellent, thanks.

Hi John and Sean — my apologies, I believe my connection dropped a bit ago.

Oh, don't worry. Thanks for coming back.