Prepared remarks
Hello, and thank you for waiting. Welcome to AAR Corp's Third Quarter Fiscal Year 2026 Earnings Conference Call. I would now like to turn the call over to Chris Tillett, Vice President of Investor Relations. Please go ahead.
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 and 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 Holmes.
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. The total sales increase included 14% organic adjusted sales growth led by 36% organic growth in our new parts distribution activity. Third, we are continuing to execute across key initiatives advancing our strategic priorities. For example, in Repair & Engineering, the integration of HAECO Americas is ahead of schedule, and our hangar expansions are on track with Oklahoma City now complete and 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 for 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 Flan again 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. Many of our customers have said publicly that the 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 on 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, and it is programs like these that helped drive a 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 2-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. Our component MRO business saw key wins from major U.S. and international carriers for expanded scopes of work, which 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- to 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 talents to forward deployed military units due to the increased operational tempo overseas. We are pleased with our results this quarter and the growth that we saw across the company. 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 & 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 part supply and integrated solutions, including Trax and government programs, despite the expected short-term impact on margins from our recently acquired HAECO Americas business, where 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 parts supply on Slide 6. Total part 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 & Engineering. Total sales increased 23% to $265 million. Sales growth was driven by the existing hangar 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. As I mentioned earlier and consistent with the outlook we described in last quarter's call, margins were negatively impacted in the quarter as we take actions 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 towards the earlier end of the 12 to 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 & 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-on-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% to 9.2%. Improved margins were driven by mix shifts 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 to 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% to 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 debenture of landing gear as well as the impact of fiscal 2026 acquisitions. We expect Q4 operating margin of 10.2% to 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 solutions in parts repair and a software platform that works 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 and 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.
Questions and answers
Our first question comes from Michael Ciarmoli with Truist.
I guess, John, regarding the topic everyone is asking about with oil prices and what we’re observing with some carriers reducing capacity. Given your extensive experience in this industry, could you provide some insight on how long we might expect elevated fuel prices to last or whether the capacity cuts by airlines will impact your business? I realize no planes are being parked yet, just some routes may be cut. Any historical context you can share on this would be helpful.
Yes. I would say that the number one thing is that fundamental demand for air travel remains very strong. That's what you're hearing from all of our major customers. And obviously, we're hearing that from them every time we talk. And they've continued to see record bookings even after the conflict started. I would say, just to your point, what you're seeing now are modest capacity adjustments, and they're not impacting any airline's individual fleets. And so adjustments like that are not going to have any meaningful impact on the demand for Parts or Maintenance. So at this point, we feel very good. All the customers are talking to us about strong bookings and being prepared for a very busy summer, and they're making those plans with the assumption that fuel prices are going to remain elevated through that period of time, which we view as encouraging because they're factoring that in, yet their demand signals to us are still very strong.
That's helpful. On a more positive note, you continue to perform exceptionally well in distribution with an organic 36% growth in new parts. Could you provide a bit more detail on that? Specifically, what new wins contributed to this? How much of that was from same-store sales or pricing? The growth is really impressive, and you're doing a fantastic job.
Yes, we're very proud of the continued growth we see in distribution, and our model there is clearly resonating. To your question, about two-thirds of the growth was same-store sales, so continued growth from contracts that have been in place for some time. The remaining one-third was mostly new contract wins, with a little bit of price across all of them, but the majority of the growth, about two-thirds of the growth came from growth from existing contracts.
Got it. Can you clarify what factors contributed to this growth? Was it related to engines, airframes, avionics, or was it strong performance across the board that you're seeing?
Great, across the board. But again, I would highlight the continued growth in Defense distribution. We've got a great offering there, and that was 55% organic in the quarter. And that though, we've been seeing a build. That wasn't a one-off. We've been seeing a build in growth in defense sales to the government. And certainly, our offering is resonating, and it reflects this administration's clear prioritization of sustainment and readiness.
Our next question comes from the line of Sheila Kahyaoglu with Jefferies.
Maybe to follow up on Mike's question. As you think about your new parts distribution business in Repair & Engineering, I know we're only seeing modest capacity cuts. How do you think about how quickly behavior has changed historically and what your visibility looks like in each?
Yes. I mean, we've got solid visibility currently through the quarter and the guidance we just provided, and I would extend that to the summer as well because that's what everybody is planning for right now. We've been in constant contact with the customers; we have not seen any material change in demand for maintenance lines or component repair. And you would have to see, I would say, much more significant changes to their fleet plans for that to have any meaningful impact on our results. The other thing I would say is that if I think about this moment that we're in relative to historical models, AAR is in a much different position in the marketplace. And I would say that we've been so focused on delivering superior service and quality to our customers that we feel pretty confident that they would deprioritize other vendors before they did anything with us.
Got it. And if I could ask another question, excellent execution this quarter. You maintained margins consistently and are expecting an improvement in Q4 despite the ongoing HAECO dilution. Can you share more about the reasons behind this strong performance? You mentioned ADI and HAECO exceeding expectations. Is there anything else noteworthy?
Those would be the big ones. ADI, the second quarter there of outperformance. HAECO, it's a lot of work. It's a lot of work to complete that integration. As we mentioned, this was the most critical quarter, and we've been able to move some of our timetables up. So happy to say if we're going to be at the earlier window. I would also highlight this was a really strong quarter for Trax. Great momentum from a sales and margin perspective with Trax. And that's something we've been focused on growing, as you know.
Our next question comes from the line of Ken Herbert with RBC Capital Markets.
Maybe first, if we look at your commercial aftermarket, John, the commercial business broadly, how much of that business would you characterize as book and shift for short cycle versus more sort of backlog driven? And I know, obviously, a lot of the heavy MRO piece of the business is now much more backlog-driven than maybe it was previously. But is there a way you would frame up that maybe that way to look at your business?
Yes. As you mentioned, heavy maintenance is primarily driven by backlog, and much of the distribution business follows the same trend. I would categorize those as the two long-cycle aspects of the business. Component repair generally operates on a shorter cycle, and similarly, USM is a shorter-cycle business. However, the majority of revenue in the commercial sector, combining distribution and heavy maintenance, is focused on longer cycles.
Okay. That was helpful. There was strong cash generation in the quarter. Can you provide any insights on what we can expect in the fourth quarter, which is usually very strong for cash generation? Also, are there any highlights from the third quarter that you or Dylan would like to share regarding the strength we observed?
We were really pleased with the cash flow results, and customers paid us on time, which we appreciate. Regarding our outlook for the rest of the year, we plan to be cash flow positive in the fourth quarter and for the entire year.
Our next question comes from the line of Scott Mikus with Melius Research.
Quick question. I know it's still early in the war in Iran. How long does this potentially have to drag on before it starts maybe impacting your ability to source any of the parts you need in your parts supply business? And then in contrast, could the worst stimulate demand for your component repair business if airlines are seeking to reduce maintenance costs to offset the higher fuel costs?
Yes, great question. I wouldn't expect at this point that the war or the conflict at any length of time would impact the supply of material. I mean, unless you're talking about USM specifically, and certainly, if for any reason, you see more aircraft retirements and subsequent teardowns, how that would result in more supply for that material. But in terms of the war or the conflict stimulating demand, yes, I mean it could stimulate demand in a number of ways, obviously, on the defense side, and we're highlighting a few of those in the results. But then also, we are in many ways a lower-cost alternative to OEMs and other providers. We have seen this in prior cycles where we're able to win business as an alternative to OEMs with airlines wanting to reduce their costs.
Okay. Got it. And then I wanted to follow up, the organic growth guide in the fourth quarter implies a deceleration, but you should be getting some revenue contribution from the OKC capacity expansion. So is that kind of just some conservatism baked into the guidance? Or is there any pull forward into this quarter from a top line perspective?
Yes. No pull forward into this quarter. Really, the impact you're seeing in Q4 is just lapping a really tough comp from last year. We had a really strong quarter in Q4 last year in a number of ways. And the guide there is reflective of that. But the guide is improved from what we implied with the Q3 guidance we gave last quarter.
Next question comes from the line of Noah Levitz with William Blair.
Yes. To start off, you gave a lot of good color on Trax and the implementation. But kind of drilling in on that, you mentioned that Delta, that the partnership with them has been deployed to 2,000 users and you expect 6,000 in the coming months. I'm curious like the 6,000 like the ninth inning? Or are you still early innings in the Delta deployment? And then following off of that, can you give a little bit more color on the timeline for Trax establishing kind of that parts marketplace aspect of the business?
Yes. Those were excellent questions. I'm pleased you inquired about the Delta implementation. There are two ways to consider it. The entire process will take around three years, and we are nearing the one-year mark. There are three modules involved. The first module involves basic functionality that has been deployed to a large user base. Currently, we've implemented this basic functionality for about one-third of the Delta users. Once all 6,000 users have access to and are utilizing this first module, we will have completed the first phase. The subsequent phases, II and III, will concentrate on adding more functionalities for that large user base, which is where we anticipate significant increases in both activity and revenue. This ramp-up is expected to begin in a few months and will extend over the next six or seven quarters. Regarding the parts marketplace, we remain focused on it and anticipate launching it by the end of this calendar year.
Awesome. And then just one follow-up. The defense business is, I mean, more or less killing it, the 55% organic growth and government distribution is really impressive. In the slide deck, you do mention that higher-margin government work was a positive contributor. I think more so in the Integrated Solutions segment. Is that something that you're expecting to continue as more or less like a new norm? Or was that more like a positive benefit this quarter that was somewhat unexpected? How should we think about specifically government margins on an improving basis going forward?
Yes. You are referring to the margin improvement in the government portion of integrated solutions government programs specifically. And that reflects sort of a mix shift towards higher-margin programs within government programs, and we do expect the benefit of that mix shift to continue going forward.
Our next question comes from the line of Michael Leshock with KeyBanc Capital Markets.
I wanted to follow up on the HAECO question, just given that that's progressing ahead of schedule. I know there was a cost element to the synergies there, but could you talk about how that integration is progressing in terms of cost-outs or operational efficiencies or just overall utilization? Is there any way to bucket the primary drivers of that integration going ahead of schedule?
Yes. To provide more detail, we need to adjust the business in several ways. It was significantly larger in terms of revenue than our intended model, as that revenue was not profitable. We're in the process of retiring the aircraft we will no longer be using. This transition is underway. Additionally, we're making tough decisions regarding workforce size to align with our new revenue levels. These adjustments have been implemented. When we mention this being the most critical quarter, it pertains to aligning our workforce with the new revenue framework, and all necessary changes have been executed. The next major tasks involve relocating operations from our Indianapolis facility to other AAR sites, primarily to HAECO and the Greenville site, and that's currently in progress. The final step, which will come after these transitions and is happening simultaneously, is the rollout of our systems. We are diligently applying our expertise on the ground. Our goal is to fully implement the paperless system we've successfully used in most AAR facilities within the HAECO sites as well. This will be the final element to finish. However, all of this is currently moving ahead of schedule. It requires considerable effort with numerous components, but I am proud of how the team is performing, and I am pleased with how the HAECO team has embraced our culture. It has proven to be a good fit.
Great. And then within Integrated Solutions, just given the recurring revenue nature of the Trax business as well as the new customer integration and ongoing upgrade cycle, should we expect growth there to be fairly linear going forward within the segment? Or is there anything that could drive lumpiness ahead?
Overall, linear, you do get lumpiness every now and then because of the way we book new implementations just based on the software and milestone accounting. So that does create some lumpiness in the results there. But the recurring revenue, which is the base of the business that we're most focused on growing, we expect that to be linear. And again, we've doubled the size of Trax since we bought it. They were a $25 million business when we closed that and are pacing north of $50 million now. Based on the customer updates, their upgrades as well as new customers that we've captured, we see a path to doubling that again from $50 million to $100 million.
Thank you. Ladies and gentlemen, at this time, I would like to turn the call back over to John for closing remarks.
Great. Thank you very much, and thank you for joining us today. We continue to execute with a high degree of discipline, and we are energized by the opportunities in front of us and really appreciate the support and interest in AAR.
Ladies and gentlemen, that concludes today's conference call. Thank you for your participation. You may now disconnect.