AAR Corp. (AIR) Earnings Call Transcript & Summary

Hello everybody, and thank you for being here on AAR's conference call covering third quarter results for fiscal year 2026. Joining us this afternoon are our Chairman, President and Chief Executive Officer, John Holmes, and our Chief Financial Officer, Dylan Wolin. You can find the slide deck accompanying today's webcast in the Investor Relations area of our company site. During this call, we will be making forward-looking statements, which are defined under the Private Securities Litigation Reform Act of 1995; such statements carry risks and uncertainties, and actual outcomes may end up differing materially from what those statements suggest. As a result, you shouldn't view these statements as a promise of how things will turn out. The company's earnings release covers these risks and uncertainties, and so does the Risk Factors section in its annual report on Form 10-K for the fiscal year that closed May 31, 2025. When the company shares forward-looking statements like these, it isn't committing to issue updates if circumstances change or if events—whether expected or not—come to pass. During today's call, we'll also go over some non-GAAP financial information. You can find reconciliations between those non-GAAP measures and the closest GAAP equivalents in the company's earnings release and slides. With that, I'll hand the call over to John Holmes.

Alright, thanks, Chris, and good morning everyone. Welcome to our Q3 FY2026 earnings call. Starting on Slide 3, I'll cover the quarter's main points. To begin, AAR had yet another exceptional quarter. Our concentrated business approach is fueling expansion that produces lasting outcomes across both commercial and government markets, which our Q3 results demonstrate. Next, we kept up that pace during the period, posting 25% growth in total sales, 31% growth in adjusted operating income, plus 26% growth in adjusted EBITDA and adjusted earnings per share. Growth occurred in every one of our parts, repair and software platform operations this quarter. Within the overall sales gain was 14% organic adjusted sales growth, driven by 36% organic growth in our new parts distribution business. Third, we keep making progress on important initiatives that push our strategic priorities forward. For instance, at Repair & Engineering, HAECO Americas integration is running ahead of plan, and our hanger expansions remain on schedule, with Oklahoma City finished and I expected to be up and running later this summer. On the parts supply side, ADI is exceeding expectations, and we keep generating exceptional growth in new parts distribution; additionally, our Trax software platform keeps building momentum by expanding recurring revenue from new and existing customers. Last, we're prudently overseeing our balance sheet to preserve strategic flexibility while sticking to a disciplined capital allocation approach; we closed Q3 with net leverage inside our target range, backed by solid operating cash flow during the period. Before moving to Slide 4, I want to welcome Dylan Wolin back to AAR as our new Chief Financial Officer. Dylan worked here from 2017 to 2024 and played a key role in shaping the strategy we're now carrying out. I'd also like to thank Sarah Flan once more for her excellent work as interim CFO these past few months. Being part of such a talented team makes me proud. I also want to briefly address the current situation. We're watching Middle East developments closely and have stayed in constant touch with our customers. Many of them have stated publicly that fundamental demand for air travel remains strong, with bookings at record levels even after the conflict began. Although certain customers might make small capacity changes, right now we don't expect any significant effect on their maintenance schedules or parts needs. They keep telling us they're getting ready for a busy summer travel season, and we're planning with that in mind. Furthermore, AAR holds a competitive position as an independent value-added aftermarket solution provider, making us an appealing choice for customers seeking to cut costs when fuel prices climb. Plus, one advantage of AAR's portfolio is our exposure to government and defense end markets. Throughout the past ten years, having that mix of government and commercial business has truly paid off. Speaking of which, demand for greater operational readiness in the U.S. military is giving our government segment a lift. Government clients currently account for about 30% of our sales and appear in every segment. AAR has longstanding experience supporting some of the U.S. military's most vital aircraft, such as the C-17, the P-8, the C-40, the F-16 and the C-130, and programs of that kind helped produce a 19% rise in government sales for the quarter and fueled our strong results. Moving now to Slide 4. We delivered 36% organic growth in new parts distribution, powered by our 2-way exclusive distribution model. Both volume and government distribution have climbed consistently across the past year, and this quarter came in at a 55% organic increase versus the same period a year ago. In Parts Supply as well, our purchase of ADI beat expectations for a second consecutive quarter, and ADI's adjusted margins proved accretive to the company during the quarter. Turning to repair and engineering, our Oklahama City facility finished expanding its hangar capacity during the quarter and started aircraft inductions in early March. We anticipate the first revenues from those maintenance lines in our fourth quarter. Key wins came to our component MRO business from major U.S. and international carriers for broader scopes of work, which demonstrates our strategy of leveraging the entire portfolio to steer more business toward the higher-margin component MRO activity. Integration of HAECO Americas is moving forward faster than planned, and we anticipate the whole integration will wrap up in the earlier portion of the 12- to 18-month window we gave before. We likewise anticipate that our acquisition of Aircraft Reconfig Technologies, or ART, will close during the fourth quarter; on the software side, Trax posted another record quarter thanks to growth from newly added customers along with upgrades by existing ones. Trax's agreement with Delta keeps ramping up, with Trax already deployed to more than 2,000 users throughout Delta, and we expect that figure to reach more than 6,000 users in the months ahead. Our Expeditionary Services business was recently granted $450 million under a multiyear government contract to supply specialized talents to forward deployed military units, reflecting a higher operational tempo overseas. We are happy with the results this quarter and with the growth seen throughout the company. And now I'd like to hand the call to Dylan so he can walk through the financial results in greater detail.

Thanks, John. If you turn to Slide 5. For the quarter, total sales were up 25% compared to the prior year, which includes organic adjusted sales growth of 14%, reaching $845 million. We achieved revenue growth across all three of our segments: parts supply, Repair & Engineering, and Integrated Solutions. Commercial customer sales rose 27%, and government customer sales increased 19% versus the same period a year earlier. During the quarter, commercial customers accounted for 73% of sales, with government customers making up the remaining 27%. Adjusted EBITDA for the quarter rose 26% year-over-year to $102.1 million, and adjusted EBITDA margin went from 12.0% a year ago to 12.1%. Adjusted operating income increased 31% to $86.2 million, while adjusted operating income margin improved by 50 basis points to 10.2%. The margin gain this quarter came from part supply and integrated solutions, including tracks and government programs, even with the anticipated near-term margin pressure from our recently acquired HAECO Americas business, where we are currently rightsizing the revenue base, adjusting the cost structure, and deploying our proprietary processes. If you exclude HAECO Americas, adjusted EBITDA margin for the quarter would have been 70 basis points higher, or 12.8%. This was the most critical integration quarter for HAECO Americas, and we anticipate sequential margin improvement as we continue through the rest of the integration process. Lastly, I want to note that we recorded a gain in the quarter related to the accounting for our HAECO Americas acquisition, which resulted in a bargain purchase. This gain reflects the excess of the fair value of the assets acquired over the purchase price and is excluded from our adjusted results. Adjusted diluted EPS rose 26% year-over-year to $1.25 per share, driven by our strong operational performance. Now turning to parts supply on Slide 6. Total part supply sales increased 45% from the same period last year to $392.5 million. We had another quarter of above market growth in new parts distribution, which grew 62% in total and 36% organically, excluding the impact of our ADI acquisition. Sales to commercial customers rose 36%, and sales to government customers increased 86%, driven by 55% organic growth in government distribution sales. Third quarter adjusted EBITDA was $59 million, up 59%, and adjusted EBITDA margin grew 130 basis points to 14.9%. Adjusted operating income rose 56% to $53.6 million, and adjusted operating margin increased 100 basis points to 13.7%. Higher margins in the period were driven by both the performance of the existing business and the addition of ADI; now on Slide 7, for Repair & Engineering. Total sales increased 23% to $265 million. Sales growth was driven by the existing hanger operations, growth in our component repair shops as we continue to add new capabilities and customers, and the year-over-year impact of the HAECO Americas acquisition. Like I said before, and in line with the guidance we gave during the previous quarter's call, profitability took a hit this quarter because of steps we're taking at HAECO Americas, which we recently bought, to bring the revenue base down to the right size, rework our cost structure, and sharpen our processes. Margins at the segment level also felt pressure from moving work away from our Indianapolis location, a site we are in the process of leaving. To put numbers on it, adjusted EBITDA margin fell 190 basis points, landing at 11.0%, while adjusted operating margin dropped 150 basis points to 9.6%. Our revenue shaping, cost structure, and process improvement efforts should wrap up nearer the start of the 12 to 18-month window following closing that we laid out before, and we believe the quarter just finished marks the bottom for margin impact. So in the third quarter of fiscal 2027, we anticipate these actions will bring quality and efficiency up to the same levels we've reached at our other airframe MRO sites, and Repair & Engineering margins should come back to where they were before the acquisition. We also expect the wind-down at Indianapolis — our costliest location — to carry on through the fourth quarter of fiscal 2027, with additional margin gains once it's finished. Now to Integrated Solutions, on Slide 8. Sales rose 3% compared to a year ago, reaching $167.8 million, lifted by Trax and government programs. Third quarter adjusted EBITDA came to $19 million, an 18% increase, and adjusted EBITDA margin climbed 150 basis points to 11.4%. Adjusted operating income reached $15.5 million, 25% greater, as adjusted operating margin moved from 7.6% up to 9.2%. Better margins came from mix shifting toward higher-margin contracts in government programs, plus expansion and stronger margins at Trax. Moving to the balance sheet, Slide 9: cash flow was solid this quarter, with $75 million generated from operating activities. Net leverage dropped to 2.17x net debt to adjusted EBITDA, well inside our 2.0x to 2.5x target range. With that, I'll hand the call back to John.

Thanks, Dylan. Now let's move to Slide 10, where I'll give you an update on how we see the rest of this fiscal year shaping up. When it comes to Q4, our expectation is adjusted total sales growth in the range of 19% to 21%. On an organic basis, we're looking at adjusted sales growth for Q4 landing somewhere between 6% and 8%, since we're going up against a really tough Q4 from a year ago; that figure leaves out the debenture of landing gear, plus any effects from fiscal 2026 acquisitions; for Q4, we anticipate an operating margin between 10.2% and 10.5%. Compared with what last quarter's guidance suggested, our Q4 outlook has gotten better, thanks to the continued strength we're seeing in our markets. So for the full year, we now expect total sales growth of roughly 19%, along with organic sales growth of roughly 12%, both above what we previously projected. . Then, on Slide 11, I'm happy to announce that AAR will hold an Investor Day on May 12 in New York City. Over the past several years, AAR has been pushing a strategic transformation, and today we have a more focused and complete set of aftermarket solutions across parts repair, plus a software platform, all working in concert to generate growth. This strategy has delivered results, as the past several quarters demonstrate. At our May event, we intend to lay out our strategic vision for how we'll keep solidifying our standing as the independent leader in aviation aftermarket, doing so through our repositioned portfolio, focused strategy and differentiated culture. We're hoping plenty of you can join us. Before we take questions, I want to thank our talented team members worldwide, who drive excellence in quality, safety and service and in the work we do for our customers. I'd also like to thank our customers and shareholders for the continued support they give AAR. With that, let's hand things to the operator for questions.

So John, I suppose on the subject that everyone's bringing up — crude oil costs, and what we're observing as certain airlines reduce their capacity. You've spent enough years in this industry. Is there any kind of gauge you can offer regarding how lengthy a stretch of higher jet fuel we'd need to witness, or once these airline capacity reductions begin to appear, would that — assuming it does at all — end up showing up in your results? And I completely understand that nobody is putting aircraft into storage at this point. They're merely perhaps cutting back on certain routes. But could you share any perspective there based on what history has shown?

Sure. What I'd say is the most important factor is — and I'm grateful for the question. The most important factor is that underlying demand for flying stays extremely robust. That's the message coming from every one of our large customers. And clearly, we hear it from them each time we speak. Plus they keep reporting record reservations even following the outbreak of the conflict. To address your point, what we're witnessing right now amounts to small-scale capacity tweaks, and those aren't affecting the individual fleets of any carrier. ; consequently, changes of that sort won't produce any significant effect on the need for Parts or Maintenance. So as things stand, our confidence is high. Every customer tells us about robust reservations and getting ready for an extremely active summer, and they're drawing up those plans while assuming jet fuel costs will stay elevated throughout that stretch, which strikes us as a positive sign since they're taking it into account, and yet the demand signals they're sending our way remain extremely robust.

All right. All right, that's useful. And now, looking at things from a brighter angle, you folks keep performing extremely strongly when it comes to distribution — that organic 36% figure on new parts — could you break that down for us somewhat? What exactly counted as fresh wins? What portion was same sale — same-store sales, perhaps pricing? I mean, genuinely impressive expansion. You people are clearly excelling in that area.

Yeah, the ongoing expansion in distribution makes us quite proud, and our approach there is obviously connecting well. Regarding what you asked, roughly 2/3 of that growth consisted of same-store sales — so ongoing gains from agreements that were already established for a while. The other 1/3 was largely fresh contract wins plus a small amount of price affecting all of them, yet most of the expansion — around 2/3 of it — resulted from gains on existing contracts.

Understood. That name really stands out. Was it tied to engines, airframes, avionics — or are you seeing strength everywhere?

Yes, everywhere. Still, I'd point to the ongoing expansion within Defense distribution. Our offering there is strong, and it came in at 55% organic for the quarter; even so, what we've witnessed is a buildup. That wasn't a single occurrence. We've observed a rising trend in defense sales to the government. And without a doubt, our offering is connecting, and it speaks to this administration's obvious emphasis on sustainment and readiness.

Perhaps I could build on what Mike asked. When you consider the fresh parts distribution operation within Repair & Engineering, I realize the capacity reductions we're witnessing are just modest. What's your view on the pace at which behavior has shifted in the past, and how much visibility do you have in each area?

Right. What I'd say is that at present we have strong visibility across this quarter and the outlook we've just given, and I'd stretch that into the summer too, since that's the period everyone is currently making plans around. Our communication with the customers has been continuous, — and we haven't observed any significant shift in demand for maintenance lines or component repair. To create any real effect on our results, you'd need to see, in my view, far bigger alterations to their fleet plans. Another point I'd make is that when I consider where we stand today compared with past mods, AAR occupies a very different spot in the market. And I'd add that our focus has been so heavily on providing top-tier service and quality to our customers that we're fairly confident they would push other vendors down the priority list before taking any action involving us.

Understood. Could I follow up with one more question? Your execution was truly impressive during this period. You kept margins level from one quarter to the next, and you're directing us toward gains in Q4 despite the continuing HAECO dilution. Could you perhaps share some insight regarding where this better-than-expected performance came from? You mentioned ADI and HAECO exceeding what was anticipated. Is there anything else worth noting?

Those are the main items. ADI, that's the second quarter where results beat projections. HAECO involves considerable effort. Completing that integration requires a great deal of work. As we said before, this quarter was the most pivotal, and we've managed to accelerate certain of our schedules. So it's a pleasure to report that we'll hit the earlier timeframe. I'd also point out that Trax had an exceptionally robust quarter. Terrific momentum on both the sales side and the margin side with Trax. And as you're aware, that's an area we've been concentrating on expanding.

Perhaps to start, John, when we consider your commercial aftermarket — the commercial operation generally — what portion of it would you describe as book-and-ship, meaning short cycle, versus the part that's more driven by backlog? And I realize, clearly, a significant chunk of the heavy MRO side is today far more backlog-dependent than it might have been in the past. Still, is there a method by which you could lay that out, maybe in that manner, for examining your operation?

Yes. Like you mentioned, heavy maintenance is unquestionably backlog-driven. A large share of the distribution operation is driven by backlog. Those two, I'd say — and clearly Trax sits with us in a category of its own, yet those would be the 2 long-cycle pieces of the business. Component repair has a tendency to be somewhat more short cycle; plus — and clearly, USM is a business with a shorter cycle; nonetheless, most of the revenue today in commercial, across distribution and heavy maintenance, is longer cycle.