AAR Corp. (NYSE:AIR) Q3 2024 Earnings Call Transcript March 21, 2024
AAR Corp. beats earnings expectations. Reported EPS is $0.85, expectations were $0.84. AIR isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good afternoon, everyone. Welcome to AAR’s Fiscal 2024 Third Quarter Earnings Call. We’re joined today by John Holmes, Chairman, President and Chief Executive Officer; and Sean Gillen, Chief Financial Officer. Before we begin, I’d like to remind you that the comments made during the call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. Accordingly, these statements are no guarantee of future performance. These risks and uncertainties are discussed in the company’s earnings release and the Risk Factor sections of the company’s annual report on Form 10-K for the fiscal year ended May 31, 2023, and Form 10-Q for the fiscal quarter ended February 29, 2024, which we expect to be on file with the SEC shortly.
In providing the forward-looking statements, the company assumes no obligation to provide updates to reflect future circumstances or anticipated or unanticipated events. Certain non-GAAP financial information will be discussed in the call today. A reconciliation of these non-GAAP measures to the most comparable GAAP measures is set forth in the company’s earnings release. A replay of this conference call will be available for on-demand listening shortly after the completion of the call on AAR’s website. At this time, I would like to turn the call over to AAR’s Chairman, President and CEO, John Holmes.
John Holmes: Thank you, and good afternoon, everyone. I appreciate you joining us today to discuss our third quarter fiscal year 2024 results. Before we discuss the results, I would like to take the opportunity here to, again, welcome the Triumph Product Support employee to the AAR family. We closed the acquisition and related financing transactions just subsequent to the end of our quarter. This business, which is now part of our Repair & Engineering segment, meaningfully scales our previous component repair operation, adds differentiated repair capability on both current and next-generation platforms, and expands our footprint into the higher growth Asian market. Integration is off to a great start and I am very, very excited about what we can do with this business.
Turning to the results, we delivered another strong quarter. Specifically, sales were up 9% year-over-year from $521 million to a third quarter record of $567 million. Sales to commercial customers increased 18%, more than offsetting a 7% decrease in sales to government customers. For Parts Supply, total sales were up 6% year-over-year, driven by strong performance in our Commercial Distribution business. In USM, demand remains exceptionally strong, which drove another quarter of growth. To break that down further, individual USM sale — part sales were up significantly year-over-year, but large asset transactions, such as whole aircraft and whole engine sales, were down. This reflects even tighter supply in this market. For example, opportunities like the 757 acquisition that we made from American Airlines last year are even more difficult to find.
Having said that, we have the best sourcing team in the world and continue to have the balance sheet flexibility to be able to act quickly when those opportunities do arise. I mentioned strong commercial distribution performance and I would like to highlight that specifically. Commercial distribution had an exceptional quarter, posting 27% organic growth. This was driven by growth from existing product lines, as well as the early ramp of recently announced wins. Government distribution had a lower quarter when compared to a very strong quarter a year ago. However, government bookings have been increasing and we expect growth to return to that business moving forward. In Repair & Engineering, sales were up 10% over the prior year quarter as we were able to drive greater volumes through our hangers.
I’m proud of the efficiency gains we continue to make with our existing footprint. In Integrated Solutions, sales were up 15% over the prior year quarter due to increased flight hours in our commercial Power-by-the-Hour program and the contribution from Trax. Finally, in Expeditionary Services, sales were down 15% over the prior year quarter due to a decline in shipments of pallets to the U.S. Air Force. As a reminder, we are the sole source provider of these pallets and we expect the DoD’s procurement volumes to return to more normalized levels in our FY 2025. Turning to profitability, our adjusted operating margin was 8.3%, up from 7.6% in the prior year quarter, driven by margin expansion in Parts Supply and Repair & Engineering. This represents our 12th straight quarter of year-over-year adjusted operating margin expansion and our margins are now approximately 50% higher than they were before COVID.
We are especially proud to have made this progress in an inflationary environment in which labor costs in particular have been rising. Our adjusted diluted earnings per share from continuing operations were up 13% from $0.75 per share to a third quarter record of $0.85 per share. With respect to cash, we generated $20 million in cash flow from operating activities from continuing operations. Our cash flow and EBITDA growth resulted in net leverage at quarter end of just under 1 times adjusted EBITDA. As you know, we elected to finance the Product Support acquisition entirely with new debt. Pro forma for the acquisition net leverage at the end of Q3 was 3.6 times adjusted EBITDA. The decision to finance entirely with debt reflects our confidence in the continued cash flow generation and EBITDA growth and our resulting ability to delever.
Turning to new business during the quarter, we announced a new multiyear distribution agreement with Ontic to supply certain military products to the U.S. Government. We also announced a multiyear contract extension and expansion for flight hour component support services with ASL Airlines. We also announced Trax agreements to provide eMRO services to Singapore Airlines, as well as eMRO and eMobility services to Archer Aviation. The Singapore Airlines award in particular demonstrates the power of the AAR track combination as AAR was instrumental in securing that award. Finally, just yesterday morning, we announced an agreement to provide surplus CFM56-5B engine material to Cebu Pacific. This agreement leverages our long-term supply partnership with FTAI Aviation and drives further predictability into our USM operations.
With that, I’ll turn it over to our CFO, Sean Gillen, to discuss the results and the acquisition in more detail.
Sean Gillen: Thanks, John. Our sales in the quarter of $557.3 million were up 8.9% year-over-year. Our commercial sales were up 17.6% year-over-year, driven by commercial growth in each of Parts Supply, Repair & Engineering and Integrated Solutions. Our commercial distribution sales were a particular standout as we continue to drive sales growth on existing product lines and expanded newly won product lines as well. Our government sales were down 7.4% year-over-year. However, sequentially, government sales were up 5% as we have started to see a recovery in our government activities within distribution, Integrated Solutions and Expeditionary Services. Gross profit margin in the quarter was 19.4%, up from 18.1% in the prior year quarter, driven by strong performance in Parts Supply, as well as Integrated Solutions, including the high margin tracks offering.
Gross profit margin in our commercial business was 19.8% and gross profit margin in our government business was 18.6%. SG&A expenses in the quarter were $77 million. This included $9.4 million of Triumph Product Support transaction expenses, $2.8 million of Trax acquisition and amortization expenses, and $2 million of investigation costs. Excluding these items, SG&A was $62.8 million or 11.1% of sales. Net interest expense for the quarter was $11.3 million, which included $6.1 million of costs related to the bridge financing commitment for the Product Support acquisition that will not recur going forward. Cash flow provided by operating activities and continuing operations was $20.4 million. This is net of inventory investments in Parts Supply, specifically in commercial distribution, which as we’ve mentioned, has significant sales growth in the quarter.
Our net leverage at the end of Q3 was 0.95 times. As John indicated, we financed the Product Support acquisition entirely with new debt, consisting of $550 million of unsecured notes with an interest rate of 6.75% and an approximately $205 million incremental draw from our revolving credit facility, which we upsized by $205 million in conjunction with the acquisition. In Q4, we expect our net interest expense to be approximately $18.5 million, which consists of $9.3 million associated with the fixed rate notes and the balance from the floating rate revolver and the amortization of financing expenses. Going forward and consistent with our reporting for Trax, our adjusted operating income and adjusted EPS will exclude non-cash amortization expense associated with purchase accounting.
Our adjusted results will also exclude transaction expenses recognized in Q4, as well as integration costs that we expect to incur over the next 12 months to 18 months. As a reminder, we indicated that we expect to generate $10 million of run rate synergies from the Product Support acquisition and expect that it will be accretive in full year fiscal 2025. However, in Q4, we expect it to be slightly diluted to earnings as the incremental interest expense associated with the acquisition will modestly exceed incremental operating process. As we also indicated previously, we will step up the tax basis, which will generate approximately $9 million of annual cash tax savings for each of the next 15 years. This will not impact our GAAP tax rate or adjusted EPS and we expect our adjusted effective tax rates to be approximately 27.5%.
Before turning the call back to John, I would like to take this opportunity to thank our bank group for their support of the financing of the acquisition. Their additional $205 million commitment to our revolver reflects their confidence in AAR and the merits of the acquisition, and allowed us to partially finance the acquisition with flexible pre-payable debt that facilitates our delevering going forward. Thank you for your attention and I will now turn the call back over to John.
John Holmes: Great. Thank you, Sean. Regarding the market going forward, the continued new aircraft delivery challenges, as well as the GTF and other engine issues means the demand for current generation aircraft and associated maintenance and parts requirements will remain strong. This is good news for AAR. While this means that USM supply will remain tight, we will continue to leverage our global surfing network to secure materials to meet this demand. This also means sustained high demand for our commercial distribution activities where we expect significant growth to continue, coming from both existing lines, as well as new contract awards. In Repair & Engineering, I am excited to announce that we expect to break ground on our airframe MRO facility expansions in both Miami and Oklahoma City this quarter.
Once complete in our FY 2026, these will add approximately 15% capacity to our network. In the meantime, we will look for ways to drive growth and higher throughput utilizing our existing footprint like we did this quarter. In Integrated Solutions, we have a strong pipeline of both government and commercial opportunities, and we expect awards will be made this calendar year. We are also encouraged by the high level of customer interest in the Trax eMRO suite of offerings. Regarding Q4, we expect revenue growth in the mid- to high-teens, including the contribution from the Product Support acquisition of approximately $65 million to $70 million in sales. And we expect adjusted operating margins of approximately 9% overall, which reflects the accretive contribution from the Product Support acquisition.
More generally, we are incredibly well positioned to continue our growth and margin expansion as we move into our FY 2025 and beyond. The Trax acquisition is working well and the thesis behind the combination is proving out as evidenced by the recently announced Singapore win. We are incredibly excited about the differentiated high margin capability that the Product Support acquisition brings and our team is already pursuing numerous opportunities with our customers. Overall, our end markets are extremely strong and we remain focused on executing on our growth strategy. With that, I’ll turn it over to the operator for questions.
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