Thank you for standing by. Welcome to AAR Corp. Q2 2025 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one one on your telephone. You would then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. I would now like to hand the conference over to Denise Pacchione. You may begin.

Thank you. Good afternoon, everyone, and welcome to AAR's fiscal year 2025 second quarter earnings call. We are joined today by John Holmes, Chairman, President, and Chief Executive Officer, and Sean Gillan, Chief Financial Officer. Before we begin, I would 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 factors section of the company's annual report on Form 10-K for the fiscal year ended May 31, 2024. 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. At this time, I would like to turn the call over to AAR's Chairman, President, and CEO, John Holmes.

Thank you, and welcome everyone to our second quarter fiscal year 2025 earnings call. I am pleased to report another strong quarter with record top-line results for Q2. Our second quarter sales of $686 million improved 26% from the same quarter last year. Our adjusted earnings of $0.90 per share were 11% higher than in the same period last year, also setting a second-quarter record for adjusted EPS. These results, which included double-digit sales growth for both our commercial and government businesses, clearly demonstrate the strong demand for our aftermarket aircraft and engine services. We are very proud of the performance we delivered this past quarter and are even more excited for the remainder of fiscal year 2025 and beyond. AAR continues to drive value throughout the company by focusing on growing our aftermarket services offering while diligently improving margins through portfolio optimization, scaling efficiencies, and realizing acquisition-related synergies. In addition to these efforts, we continue to benefit from a strong aviation aftermarket, due to the elevated levels of consumer air travel and aging fleet, and increasing demand from the government end market. The strong demand is not slowing down, and we expect it to continue through calendar year 2025. As mentioned, we delivered quarterly sales of $686 million, up 26% year over year. Moreover, we saw an increase in organic sales growth, which accelerated from 6% last quarter to 12% this quarter. All three of our core business segments contributed to this growth. Part supply remains our largest segment by sales, due to strong demand for both new and used parts. Sales grew 20% over the last year, and it was entirely organic. Our repair and engineering segment grew 57% over the last quarter, as a result of the product support contribution and continued strong demand in our hangars.…

Thanks, John. Total sales in the quarter grew 26% to $686 million, setting a new company quarterly sales record. Excluding the impact from the recently acquired product support business, organic sales growth for the quarter was 12%, which accelerated from last quarter's organic growth rate of 6%. Promotion sales increased 30% during the quarter compared to 20% from the prior quarter. This additional increase in sales growth came from all three of our core business segments, led by commercial distribution and product support sales. Government sales also increased 16% for the quarter, primarily due to increased order volume and new parts distribution. Total commercial sales for the quarter made up 73% of total sales, while government sales made up the remaining 27%. Compared to the same quarter last year, adjusted EBITDA margin increased from 10.1% to 11.4%. Adjusted operating profit margin improved from 8.1% to 9.2%. Our focus on airframe maintenance efficiencies and contribution from our recently acquired product support business has helped us significantly improve margin performance. Net interest expense for the quarter was $18.8 million, reflecting the financing of the product support acquisition. We expect Q3 net interest expense to remain consistent with these levels. We also expect our Q3 effective tax rate to be approximately 27%. Average diluted share count in the quarter was 35.5 million shares. Adjusted diluted EPS increased from $0.81 to $0.90, reflecting the benefit of our growth and margin expansion. With that, I'll turn to the detailed results by segment. Part supply sales were up 20% to $274 million, driven by growth in both distribution and USM. An increase in commercial volume drove growth in both businesses, along with an uptick in government demand for new parts distribution. Part supply adjusted EBITDA margin decreased from 13.2% to 12.4%, and adjusted operating margin decreased…

Great. Thank you, Sean. I am very pleased with our second-quarter results and the continued momentum since the beginning of this fiscal year. Regarding the balance of the fiscal year and for Q3 specifically, we expect year-over-year sales growth of 22% to 25% and adjusted operating margin in the range of 9.2% to 9.4%. As I look ahead into the balance of our fiscal year and into next fiscal year, we expect to continue to see strong demand for our services. The overall macro environment for commercial aviation remains very strong. In addition, we have multiple levers to continue to drive significant growth. We have strong bookings and new contracts ramping up in distribution, and we are seeing more assets come available to fuel growth in our USM activity. In repair and engineering, the two hangar expansions are expected to contribute growth in the next fiscal year, and our global sales team will drive incremental growth across the recently acquired product support business. Finally, in integrated solutions, we have a strong pipeline of new opportunities across our government and commercial offerings, including tracks. Turning to profitability, we continue to make tremendous progress towards executing on our long-term objectives. I am incredibly proud of the progress we have made. Our adjusted operating margins are up from 5.5% pre-COVID to 9.2% today, and we expect continued improvement. The margin expansion from here will primarily come from three areas: First is realizing synergies from our recent product support acquisition. As I mentioned earlier, we expect to achieve the run-rate $10 million of synergy in Q1 of next fiscal year. Further, as we drive more volume through the product support site, we anticipate additional margin expansion. Second is in our heavy maintenance hangar network. The new capacity coming online next fiscal year will not only drive growth but also improve operating margins as we leverage the existing cost structure to meet the increased demand. Additionally, in the hangars, we expect improved efficiencies driven by several digital initiatives that we have invested in over the last several years. The third will come from mix benefit as we drive growth in our part supply segment. We continue to see significant opportunity in distribution as evidenced by our strong pipeline of OEM contracts and recent wins. As these new distribution agreements mature, we expect additional margin expansion. It is important to note that the exclusive contract focus for our distribution business allows us to earn higher margins than traditional distribution models due to the added value that we provide to both suppliers and customers. And continuing to reduce our leverage. Before turning it over to the operator for questions, I would like to thank our team of dedicated employees, our customers, and our shareholders for your continued interest and support of AAR. With that, we will open it up for questions.

Thank you. Ladies and gentlemen, as a reminder to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Scott Mikus with Melius Research. Your line is open.

Good evening, John, Sean. You mentioned the new distribution agreement with Chromalloy for PMA parts on the CF6 engine. Chromalloy also PMAs some parts on the CFM56 and V2500 for Eftai. Are there any restrictions that would prevent you from distributing those PMA parts for those engines? And if so, is there some sort of deal that could be worked out with Eftai and Chromalloy to let you distribute those PMAs for the CFM56 and V2500?

You know, appreciate the question. What I would say there is we're very aware of the PMA portfolio that Chromalloy has. And, obviously, we've got a joint venture with Eftai and now a long-term relationship with Chromalloy. There are a number of other discussions that we're having with both of them as existing partners, and the three of us are always looking for ways to grow the business together.

Okay. And then another question on just the broader market and the commercial aftermarket. There's a lot of questions regarding the long-term viability of some of the low-cost carriers in the US. So just wondering if you could size your revenue exposure to some of the ULCCs.

Yeah. Great question. We are heavily skewed towards the larger carriers. Our largest customers are United Airlines, Delta Airlines, American, etcetera. And so while we do some business with the lower-cost carriers, it's a very small part of our business in North America.

Okay. Got it. And then one quick question for Sean. Sean, if you happen to have it, do you have the organic growth numbers for commercial and government?

No. I do not have that handy. I mean, you can back into it in terms of the inorganic growth, you know, came from TPS, and most of that is commercial activity. So I could help you get to something close to that, but we do not disclose organic growth by usual activities.

Okay. Got it. Thank you for taking the questions.

Thank you. Please stand by for our next question. Our next question comes from the line of Ken Herbert with RBC Capital Markets. Your line is open.

Hey. Good afternoon, John and Sean.

Hey, Ken.

Hey, John. You mentioned growth in the second quarter in your USM portfolio. Can you help quantify that and maybe talk a little bit about sort of where you're seeing that specifically on the whole asset side? And how should we think about that into the second half of the fiscal year in terms of is that accelerating? Is it sort of moving sideways? How much upside can that provide into the back half?

Let's see. We're not breaking out growth specifically by USM. But what we can say is that it absolutely accelerated from the first quarter to the second quarter. And we are seeing growth in USM. In terms of assets available for sale, we're seeing many more now than we did a quarter ago. It's hard to call that a trend because we're a quarter into it. But generally speaking, we are having more conversations and again seeing more assets available that fuel growth in this quarter, and we would expect more growth through the balance of the fiscal year as long as we're able to capture those assets.

How is pricing on some of these assets, like, for instance, legacy engines like CFM56 and V2500, for example? Are you continuing to see upward pressure on pricing? Are you starting to get a sense that maybe that market's peaked? What are you seeing in terms of pricing on some of the legacy engines?

I'd say the pricing, the values are still very, very strong. I would not say that they are accelerating at the rates that we had seen, but they're still very, very strong. And, of course, the prices that we pay for assets we're able to command equally strong pricing in the market to preserve our spreads.

Okay. Great. And last year in fiscal 2024, you saw a real sequential first half, second half uptick in margins in the part supply business. As we think about sort of the cadence first half, second half, I know you do not give specific guidance maybe by segment, but directionally, how do we think about margins in parts supply? And is there any reason we would not see sort of similar strengthening into the back half in that segment margins?

I do not have the last year margins specifically in front of me, but we do expect margin expansion in the second half of our year versus the first half of the year. So Q3 margins, as we said, would expand into Q3. And then also, we would expect expansion on top of that in Q4. And that's driven, you know, across the company, but related to part supply specifically, as new distribution agreements that we signed ramp up, we typically see margin expansion there. As you know, we've been stacking win after win on top of each other, so you've got a compounding effect in the distribution business. And in USM, now that we're seeing more assets available to us, we would expect further growth in USM. The margin profile of USM is worth to predict because it's such a transactional business. And so when you're dealing with assets as they become available, but generally speaking, the part supply, we would expect to see an upward trend largely driven by distribution.

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

Great. Thanks, Ken.

Please stand by for our next question. Our next question comes from the line of Michael Ciarmoli with Truist Securities. Your line is open.

Hey. Good evening, guys. Thanks for taking the question. Nice results.

Thank you.

Sean, maybe just to stay on the margins. I think I heard you say the part supply EBITDA margins were down year over year. I think you called out maybe the mix for whole asset, but even down sequentially, is there any reason for concern? Any change with underlying distribution margins there by customer, either commercial or government, or was it everything truly just whole asset related?

No reason for concern. It's largely driven by the whole asset. So last year, we had whole asset sales that were at a higher margin. This year, we had whole asset sales that were at a lower margin. And that's simply the nature of that business, based on what whole assets become available for us and the cost to get into those assets. So I would not focus on that as any sort of trend. I think the important thing to note is that whereas in the first quarter of this year, we had really struggled to find whole assets at all to sell, we were pleased to see assets come available to us that were closed in the quarter, and we have a much stronger pipeline of assets available to us as we go throughout the balance of this fiscal year.

That's a great point. On that topic, what do you think is driving that? I mean, it's obviously Boeing and Airbus are still struggling likely to get back to go. Or, I mean, what's driving that change?

Yeah. Exactly. I would not say that this is related to increased production rates, except I think, again, it's situational. And, you know, we've got a very, very talented sourcing team that's able to find assets out there in the market. And I believe we're doing a good job of outperforming the competition and getting our hands on assets ahead of them. So I would not characterize this as a trend related to increased production out of the OEM. I think that you are seeing maybe a slight loosening due to some of the things going on with the lower-cost carriers and the larger lessors, their lead portfolios. But, again, I would characterize that as situational right now. And we're just playing a really good ground game to make sure that we're on the line when those things become available.

Got it. And maybe just last one, Sean. Can you maybe level set us, you know, the R&E margins so you're, you know, maybe by February or so, you get rid of the money-losing landing gear. Can you calibrate us in terms of just for modeling revenue and then what that actually does to margins? And I don't know if it's material enough that it moves the needle for kind of three to five-year targets you put out there for margins, but presumably, it's gonna help.

Yeah. I would say it's part of achieving the three to five-year targets in terms of the margin expansion, what will happen in R&E. And as John mentioned, it's really gonna come from two primary things, the realization of the synergies associated with the product support acquisition, which the completion of that kind of gets into that $10 million number, as John said, will be in our Q1 of the next fiscal year here. That's when that'll be complete and realized. And then the other piece from that will come from the hangar expansions. And so both of those are kind of next fiscal year for that next bigger move in margin. In the more near term here, I think we'd expect pretty consistent performance, maybe a slight improvement, as you mentioned, with landing gear coming out. I would note the landing gear won't come out of the results until the deal closes. So for our fiscal Q3, it will likely be in the results and then out of the Q4 results.

Got it. Alright. Thanks, guys. I'll jump back in the queue.

Thank you, Mike.

Please stand by for our next question. Next question comes from the line of Louie DiPalma with William Blair. Your line is open.

John, Sean, and Denise, happy New Year and good afternoon. And, Denise, congrats on joining the AAR team.

Thank you.

My question, USM seems to have hit an inflection with your commentary about the better supply, and this quarter's growth after recent declines. John, would you say that the worst is behind us in terms of USM and have we turned a corner there?

Again, I think it's early, so it's been a quarter, you know, a quarter of loose. But I would point back to we've been talking about this for some time that we expect at some point, we will enter a period where you still have extremely high demand material, and you'll start to see more supply come on the market. And that will provide a great opportunity for us to accelerate the growth of USM. We definitely saw that this quarter. We are seeing it through the balance of this fiscal year. You know, beyond that, it's tough to tell. That's just the nature of that business. But, you know, certainly, very, very early signs are encouraging. That we will be in an environment where we have more supply to meet the very elevated demand.

And so along those lines, you would forecast for there to be a period of time in which both distribution and USM are both clicking at the same time. Right?

Well, they definitely clicked at the same time this quarter. Yeah. And distribution, you know, distribution, it's a very different business than USM. Right? Because you have an assured supply out of your OEM partners. And in many cases, because of the nature of the product, we, you know, it's much more forecastable and the backlog is much larger. I should say that the backlog for both commercial and government and distribution has been growing. And that's on existing lines as well as the new lines that we've been signing up. So, you know, distribution's been on just a tremendous run for the last several years. And we absolutely expect that to continue thanks to the compounding of all the new contracts that we continue to sign. And there again, going back to USM, you know, again, a much different business with different dynamics. But, you know, this was a very good quarter where we saw strong demand and strong asset availability. And you can see it come through in the results.

Great. And you announced the new distribution agreements with Chromalloy, as you discussed in your response to the first question, and the Wipany, the TransDigm company. But how long should it take those distribution agreements to scale to a normalized rate as I think they were signed in November? So will there be contributions in, like, the fiscal year, or is it more of like, fiscal 2026?

That's a great question. And the answer is it varies by contract. In the case of the Chromalloy contract, we would expect an immediate contribution starting this quarter and ramping likely to close the full run rate by the end of this fiscal year. So that one is on a relatively nice path. Wipany, along with other distribution agreements on the new parts distribution side, typically have a longer ramp. And the reason is often you are taking that business from another distributor, and they may still or multiple distributors, and those prior distributors may have inventory sitting on the shelf that it just takes a while for the channel to drain out and then to ramp fully over to us. So Wipany, I would expect to ramp over a multi-quarter period and be more of a contributor in our FY26.

Right. So Wipany was a takeaway.

Yeah. I believe that one was. But let's let me confirm that.

Gotcha. And for Sean, many different stocks in the stock market over the past month or so have been under pressure due to the rise in interest rates with the ten-year yield spiking, and we were wondering what is your long-term view of net leverage and your appetite for M&A in regards to the recent increase in interest rates and the deleveraging plan.

So, yeah, as you mentioned, deleveraging is a focus of ours. You've seen pretty significant deleveraging from 3.6 at deal close to 3.17 today and would look to stay on track to get towards 2 times net leverage in two years post-close of the acquisition, which we're on track for. And in terms of the rising interest rate environment, we have a combination of fixed and floating. We have fixed-rate debt on the $550 million bond we put in as part of the acquisition, so no exposure to rising interest rates there. The revolver is floating, and so there's a little bit of exposure there, but that's the instrument we'd be using to pay down debt. So that portion of the capital stack would come down as we delever. As it relates to appetite for M&A, in the near term here, we're clearly focused on integrating TPS, realizing the synergies, and deleveraging, but we do continue to expect to play offense as it relates to acquisitions in the aftermarket.

Awesome. Sounds good. Thanks, everyone.

Thank you.

Please stand by for our next question. Our next question comes from the line of Josh Sullivan.

Hey. Good evening.

Hey, Josh.

Can you just expand on commentary you made around potentially being part of the DOD conversation or helping with any government efficiency efforts? And then I know this is probably the third rail conversation, but can PMA fit into that conversation as well?

Yeah. I would say, you know, just to answer the last part first, certainly PMA can be part of that conversation. But for and we're in that business, and it's still a very small effort for us, but a focus. I would say more broadly in the areas where we have a much greater impact would be simply the utilization of used parts by the government. And we've said many times that if the US Air Force bought parts like Delta Air Lines, there's billions of dollars in potential savings there. And one example, what I believe everyone on the call is familiar with, is when we sold two used C-40 aircraft to the Marines. And, you know, as you know, a C-40 is the 737, a commercial derivative aircraft converted for military use. The government was going to buy two factory-new C-40s from Boeing. We convinced the government that they could achieve the same objective by buying used aircraft. We worked with the government to source aircraft and ultimately convert used 737s to C-40s. And those aircraft have since been delivered to the Navy, Marines, and are in operations today. We were able to save the government approximately $60 million on two aircraft alone. And so when we think about DOD and the approach to looking at how can we be more efficient, we are hopeful that they will look to commercial solutions like what we offer and apply more of those commercial solutions to the government setting. And we've got great examples like the C-40 we've talked to them about.

Great. I'll keep it to one. Thank you.

Okay. Great. Thank you.

Please stand by for our next question. We have a follow-up question from the line of Ken Herbert with RBC Capital Markets. Your line is open.

Okay. Hey, John. Yeah. Appreciate the follow-up. Just two quick questions. First, as you start to maybe do more in PMA, and it sounds like it's limited initially, but are you managing any potential sort of conflicts with some of your OEM partners? And I'm just thinking specifically, you know, Unison's obviously been a great relationship and a great product line for you. Is that something that's at all a concern, or how are you managing that as you communicate into the marketplace?

We are managing those relationships very, very carefully. We would never do anything that would run afoul with our OEM partners in distribution or any other part of our business. The good news is, as you know, there are thousands and thousands of parts on the aircraft. And there are lots of OEMs out there, big ones, small ones that we do not have any conflict with. And those are the type of parts that we are targeting.

Okay. Perfect. And maybe just for Sean, can you give any color on the free cash flow outlook for the year? I mean, nice quarter this quarter. Typically, you have a very strong quarter in your fiscal fourth quarter. How's thinking on full-year free cash shaped up, and should the trajectory look similar this year as it has in prior years with the fourth quarter?

Yeah. I think the trajectory should look pretty similar. Obviously, the only thing different being the FCPA payment and the timing of the close of landing gear, but those are both happening either all in Q3 or certainly in the second half of the fiscal year. As it relates to the balance of the free cash flow, I think it should look pretty similar to last year in terms of positive cash in Q3 and a stronger Q4 to close up the year.

And that'll help as we think about the deleveraging.

That's a piece of it, and then the EBITDA growth will be another piece.

Perfect. Thanks, Sean.

Thank you.

Ladies and gentlemen, at this time, I would like to turn the call back over to management for closing remarks.

Great. Well, thank you very much. We really appreciate you all joining us today, and we look forward to being back next quarter to talk about the Q3 results. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.