AAR CORP Q3 2026 earnings call

Good afternoon, everyone, and welcome to AAR's Fiscal Year 2026 Third Quarter Earnings Conference Call. We're joined today by John Holmes, Chairman, President, and Chief Executive Officer, and Dylan Wolin, Chief Financial Officer. The presentation we are sharing today as part of this webcast can be found under the Investor Relations section on our corporate website. Comments made during the call will 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 in the Risk Factors section of the company's annual report on Form 10-K for the fiscal year ended May 31, 2025.

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 during the call today. Reconciliations of these non-GAAP measures to the most comparable GAAP measures are set forth in the company's earnings release and slides. At this time, I would like to turn the call over to John.

Great. Thank you, Chris, and welcome everyone to our Third Quarter Fiscal Year 2026 Earnings Conference Call. I'll begin with key messages for the quarter on slide 3. First, this was another outstanding quarter for AAR. Our focused business model is driving growth that is delivering durable results in both commercial and government end markets, as evidenced by our third quarter performance. Second, we continued our momentum in the quarter and delivered 25% growth in total sales, 31% growth in adjusted operating income, and 26% growth in both adjusted EBITDA and adjusted earnings per share for the period. We saw growth across each of our parts repair and software platform activities in the quarter. Total sales increase included 14% organic adjusted sales growth, led by 36% organic growth in our new parts distribution activities.

Third, we are continuing to execute across key initiatives advancing our strategic priorities. For example, in repair and engineering, the integration of HAECO Americas is ahead of schedule and our hangar expansions are on track, with Oklahoma City now complete and Miami expected to be operational later this summer. In parts supply, ADI is performing above expectations and we continue to drive outsized growth in our new parts distribution activities. Also, our Trax software platform continues to gain momentum by growing its base of recurring revenue with new and existing customers. Finally, we are carefully managing our balance sheet to preserve strategic flexibility as we maintain our disciplined approach to capital allocation. We ended the third quarter with net leverage within our target range, supported by our strong operating cash flow in the period.

Before I go to slide 4, I would like to welcome Dylan Wolin back to AAR as the company's new Chief Financial Officer. Dylan was with the company from 2017 to 2024 and was instrumental in developing the strategy we are executing today. I would also like to thank Sarah Flanagan for doing an outstanding job as our Interim CFO over the last few months. I'm proud to be part of such a strong team. I also want to talk for a moment about the current environment. We are closely monitoring the events in the Middle East and have been in constant contact with our customers. As many of our customers have said publicly, fundamental demand for air travel remains strong, with bookings at record levels even since the start of the conflict.

While some customers may make modest capacity adjustments, at this time we are not anticipating any meaningful impact to their maintenance schedules or need for parts. They continue to tell us they are preparing for a busy summer travel season and we are planning accordingly. What's more, AAR is competitively positioned as an independent value-added aftermarket solution provider which makes us a compelling solution for our customers as they look to reduce spending when fuel costs rise. Additionally, one of the benefits of AAR's portfolio is our exposure to government and defense end markets. Over the decade, this balance between government and commercial markets has been a real advantage. On that note, the government side of our business is benefiting from a general need for increased operational readiness in the U.S. military.

Our government customers today comprise roughly 30% of our sales and are represented across all segments. AAR has a long history of working on some of the most critical aircraft for the U.S. military including the C-17, the P-8, the C-40, the F-16 and the C-130. It was programs like these that helped drive 19% increase in government sales this quarter and contributed to the strength of our results. Now on to slide 4. We achieved 36% organic growth in new parts distribution, driven by our two-way exclusive distribution model. Volume and government distribution have been increasing steadily over the last year and this quarter represented a 55% organic increase over this period last year. Also in parts supply, our acquisition of ADI outpaced expectations for the second quarter in a row and ADI's adjusted margins were accretive to the company in the quarter.

In repair and engineering, our Oklahoma City facility completed its hangar capacity expansion in the quarter and began aircraft inductions in early March. We expect first revenues from these maintenance lines in our fourth quarter. Component MRO business saw key wins from major U.S. and international carriers for expanded scopes of work, and this is a testament to our strategy to utilize our whole portfolio to drive more business to the higher margin component MRO activity. Our HAECO Americas integration is progressing ahead of schedule, and we expect the full integration process to be complete in the earlier part of the 12-18 month window we provided previously. We also expect our acquisition of Aircraft Reconfig Technologies, or ART, to close in the fourth quarter. In our software activities, Trax had another record quarter as a result of growth with the addition of new customers as well as existing customer upgrades.

Trax's agreement with Delta continues to ramp. Already, Trax has been deployed to more than 2,000 users across Delta, and we expect this to increase to more than 6,000 users in the coming months. Our expeditionary services business was recently awarded $450 million in a multiyear government contract to provide specialized pallets to forward deployed military units as a result of increased operational tempo overseas. We are pleased with our results this quarter and the growth that we saw across the company, and I would now like to turn the call over to Dylan to go through the financial results in more detail.

Thanks, John. Looking at slide 5, total sales in the quarter grew 25% year-over-year, including 14% organic adjusted sales growth to $845 million. We drove revenue growth in each of our parts supply, repair and engineering, and integrated solutions segments. Sales to commercial customers were up 27%, while sales to government customers were up 19% over the same period last year. For the quarter, 73% of our sales were to commercial customers, and the remaining 27% were to government customers. Adjusted EBITDA in the quarter increased 26% year-over-year to $102.1 million, and adjusted EBITDA margin increased to 12.1% from 12.0% a year ago.

Adjusted operating income was up 31% to $86.2 million, and adjusted operating income margin improved 50 basis points to 10.2%. The margin improvement in the quarter was driven by parts supply and integrated solutions, including Trax and government programs, despite the expected short-term impact on margins from our recently acquired HAECO Americas business, at which we are in the process of rightsizing the revenue base, adjusting the cost structure, and deploying our proprietary processes. Excluding HAECO Americas, adjusted EBITDA margin in the quarter would have been 70 basis points higher or 12.8%. This was the most critical integration quarter for HAECO Americas, and we expect sequential margin improvement going forward as we move through the remainder of the integration process.

Finally, I'll mention that we recorded a gain in the quarter due to the accounting for our HAECO Americas acquisition resulting in a bargain purchase. The 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 was up 26% year-over-year to $1.25 per share, driven by our strong operational performance. Turning to part supply on slide 6. Total parts supply sales grew 45% from the same period last year to $392.5 million. We had yet 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 were up 36%, and sales to government customers were up 86%, driven by 55% organic growth in government distribution sales. Third quarter adjusted EBITDA of $59 million was 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 and engineering. Total sales increased 23% to $265 million.

Sales growth was driven by the existing hangar operations, growth at our component repair shops as we continue to add new capabilities and customers, and the year-over-year impact of the HAECO Americas acquisition. As I mentioned earlier, and consistent with the outlook we described on last quarter's call, margins were negatively impacted in the quarter as we take action at the recently acquired HAECO Americas operation to rightsize the revenue base, adjust the cost structure, and improve processes. Segment margins were also impacted by the transition of work out of our Indianapolis facility, which we are in the process of exiting. Specifically, adjusted EBITDA margin decreased 190 basis points to 11.0%, and adjusted operating margin decreased 150 basis points to 9.6%.

We expect our revenue shaping, cost structure, and process improvement actions to be completed toward the earlier end of the 12-18 month post-closing timeline that we articulated previously, and for the quarter that we just ended to be the low point in terms of margin impact. Accordingly, we expect in the third quarter of fiscal 2027, our actions will result in the same quality and efficiency levels as we have achieved in our other Airframe MRO facilities and for repair and engineering margins to return to pre-acquisition levels. We expect the transition out of the Indianapolis facility, which is our highest cost site, to continue into the fourth quarter of our fiscal 2027 and to realize further margin improvement once that is complete. Looking at integrated solutions on slide 8.

Sales increased 3% year-over-year to $167.8 million, driven by Trax and government programs. Third quarter adjusted EBITDA of $19 million was up 18%, and adjusted EBITDA margin grew 150 basis points to 11.4%. Adjusted operating income of $15.5 million was 25% higher, with adjusted operating margin increasing from 7.6%-9.2%. Improved margins were driven by mix shift towards higher margin contracts within government programs, as well as by growth and higher margins at Trax. Turning to the balance sheet on slide 9. We had a strong cash flow quarter, generating $75 million in cash from operating activities. Net leverage decreased to 2.17 times net debt to adjusted EBITDA, comfortably within our target range of 2.0 times-2.5 times.

With that, I'll turn the call back over to John.

Thank you, Dylan. Turning now to slide 10 for an update on our outlook for the remainder of the fiscal year. For Q4, we are expecting total adjusted sales growth of 19%-21%. Organic adjusted sales growth for Q4 is expected to be between 6% and 8% as we lap what was a very strong Q4 last year. This excludes the divestiture of Landing Gear as well as the impact of fiscal 2026 acquisitions. We expect Q4 operating margin of 10.2%-10.5%. Our outlook for Q4 has improved from what was implied in our guidance last quarter, given the ongoing strength we see across our markets. As a result, our full year expectation is for total sales growth of approximately 19% and for organic sales growth of approximately 12%, which is up from our prior outlook.

Finally, on slide 11, I'm excited to share that AAR will be hosting an investor day on May 12 in New York City. AAR has been driving strategic transformation over the last several years, and we have a more focused, complete range of aftermarket solution in parts repair and a software platform that work together to drive growth. As the last several quarters have shown, this strategy has yielded results. At our event in May, we plan to share our strategic vision of how we will continue to cement our position as the independent leader in aviation aftermarket through our repositioned portfolio, focused strategy, and differentiated culture. We hope to see many of you there. Before we open it up for questions, I'd like to thank our talented team members around the world as they drive excellence in quality, safety, and service in the work we do for our customers.

I'd also like to extend a thank you to our customers and shareholders for their ongoing support of AAR. With that, we'll turn it over to the operator for questions.