Securing the Future of Aviation Maintenance with AAR Corp. CEO John Holmes

Thank you, Craig. Appreciate you taking the time to talk to us today.

Well, thank you. I appreciate you taking the time to read the article. You're absolutely right. This is something that's been important to AAR for a very long time. We've been around for over 60 years, and over the last 10 or 15 years, we've really come a long way in making a name for ourselves in the world of heavy maintenance. We're the largest in the Americas and the third largest in the world for heavy maintenance, as you look at the number of labor hours produced each year. Workforce development and recruitment has always been important to us because we're independent. We're not part of an airline or part of an OEM, so we really have to make a name for ourselves in a different way. Things kicked into high gear a little over a year ago. We're also a seasonal business because during the summer we're typically very quiet, as the airlines have all their aircraft operating and are busy. Then in the fall, they bring them back for maintenance, and that's when our hangars fill up. So during the summer, our workforce typically decreases by a meaningful amount to correspond with that lower volume, and then in the fall we go back into the market and hire hundreds of people across our seven locations in North America. What happened last year is when we went back into the market, the economy obviously is very strong, which is great, but it's the tightest labor market we've ever seen. So when we went back into the market, we found it very, very challenging to find qualified labor for really the first time in our history. So we took a serious look at this, and as we came to realize the macro trends are difficult — you've got a retiring workforce, you've got, at least where we are, the pay is different than you might see in an airline MRO or OEM — so we had to figure out a way to get creative to develop our own proprietary pipeline of labor. That's when we launched a number of the programs that you read about in the Forbes article. Our Eagle Quick Career Pathway program has been very successful. We partnered with five schools so far, actually six schools so far, and we have a few more in the pipeline that we're looking at. That's been a really great pipeline of people. We've also launched a number of internal initiatives built around the company's values. We're really proud of the values we have and the culture we have. The idea is to use the career pathway to get people introduced to AAR very early in their career, and then hook them in and keep them with all the other great things we do once we've got them internal.

Yeah, it's a long road. It can take a couple of years to become an AMT mechanic, and we have a very high percentage of A&P mechanics in our workforce, higher than most of our competitors, because we're looking for the highest quality people to deliver the highest quality product results. In terms of the challenge, number one is just finding the people in the markets we operate in that meet our very high qualifications. Once we find them, getting them in the door and bringing them along and ultimately helping them get their A&P license is a challenge. We also can't compete dollar for dollar necessarily with the airlines and the OEMs, to be very blunt. Many of them are unionized, they might offer flight benefits, there are other things they can offer that we can't because of our independent nature. Where we do compete is just creating a great place to work. Whether it's tuition assistance, helping with your A&P license, flexible hours, a very healthy and friendly work environment — those are the areas where we compete. Notwithstanding the pressures on the labor market, we're very excited about the fact that our retention, historically and even now in this very tight market, is actually quite good.

We've learned a lot about that over the last year-plus. Historically, we would really look for experienced hires, somebody with five to ten years of experience, and that was the primary source of our recruiting. Because of the type of labor market and because of these partnerships we've launched with the schools, we're now doing a lot earlier. We're working in high schools, we're working in colleges, so we have a chance to assess the talent very early on. I would agree with you — by and large, we're really impressed. But we want to get people excited about careers in aviation. There are a lot of things that smart kids can do, and I think making people aware of the type of career you can have — these jobs are going to be around for a very long time. There's a lot of disruption in the world, but the need for a mechanic, an actual person to work on aircraft, that's not going anywhere anytime soon. It's also been fun to open some of these kids' eyes to the amount of money you can make. These are careers that pay very well, and you're working on aircraft, which is cool, and you do that in a good environment. So far, we've got some really nice traction dipping down to the younger level. I was really proud that we launched a program at the end of last year and went live in April here in Chicago. We partnered with Mayor Emanuel, with the city colleges here in Chicago. It's the first time we had done anything like this. It's a little bit different than the other career pathway programs because in this case, we were starting a school, whereas in those cases we were partnering with existing schools. What we did in Chicago is there was a city college on the south side called Olive-Harvey, and they were investing some money to develop a new transportation campus, but it was focused on ground transportation. We worked with the mayor to get an additional focus on aviation. AAR went out and found an instructor, wrote the curriculum, donated tooling and equipment, and actually got some aircraft donated for the kids to work on. Ultimately, we provide scholarships. I was really happy that we kicked it off in April and graduated our first class about two weeks ago. Almost all the kids that started in the class graduated, and we're in the process of trying to get as many of them on board as we can to AAR. That kind of organic effort, particularly in an area of Chicago that really needs help in this regard, is something we're really proud of, and we would look to potentially duplicate that in other cities as well in partnership with city colleges.

Exactly. And the path from there is blue skies ahead. Those jobs will be around a long time. You talk about kids — I think about my six-year-old who's in kindergarten, and he's in woodshop, playing with 3D printers, doing all this stuff. That tactile work is very gratifying.

We view this as we want proprietary pipelines of talent wherever we can find them. These partnerships with the schools that we're starting are not just about AAR, but about the whole aviation industry. We're going to need several hundred thousand, 700,000 mechanics in the country to support the growing fleet and to deal with the upcoming wave of retirements over the next several years. All of us in the industry need to be focused on this. It's not just about being a pilot or working for an airline or working for an OEM like SpaceX or Boeing. There's this whole network of providers out there, and the independents — we're the largest among them — need access to this talent. We're very pleased to be leading that charge.

All of those things are on our minds. Let me highlight a couple of elements that are important to us as we think about the company. One, the fleet of aircraft that exists today — there are thousands and thousands of current-generation 737s, A320s, and 777s that are our bread-and-butter aircraft. Those aircraft are going to be flying in operation for a long time. From a base-case scenario, we see the fundamentals for that business being very strong for a very long time. We had an Investor Day in New York last week where we gave some statistics in this regard. It does get exciting when you think about the next generation of aircraft — notwithstanding the current issues with the MAX, but the A320neo, certainly the 787, the A350, and ultimately as those aircraft mature and need maintenance, we're counting on being in a position to support them. The other area of the company that's exciting that we haven't talked about is the work we're doing for the government. We've won several billion dollars in contracts with the US government as a prime contractor over the last couple of years. That's new for AAR. We've been a participant in that market in various ways for a long time — we had some government manufacturing, we still do, we manufacture pallets, shelters, and containers that get sold to the government. But from a programmatic and supply chain standpoint, we decided a few years ago that we were going to make the move from a subcontractor to a prime contractor. We had been a participant on various programs as a subcontractor to some of the big primes like Northrop Grumman. As a result of those roles, we really learned how to do a lot of interesting things, and we were also learning a lot on the commercial side. We felt that approaching Washington, whether it's the DoD or the Department of State, with a true commercial-based solution was a unique offering. Many of the companies we compete against as a prime contractor grew up as defense contractors, so they've existed in a government cost-plus environment. We came out of commercial, and now we're truly the only ones out there applying commercial best practices to government offerings. The government world is a lot different than the commercial world, and we're finding our way through that, but we've been very successful in the last few years in winning some very significant prime contracts. I'm excited about taking what we've learned on the commercial side and bringing those solutions to the government.

That was a program we were on as a sub to Northrop Grumman. We played a critical role in that program. It's one of those things where there were three different things being integrated, and in our view, we were performing the most complicated set of tasks. That gave us the confidence to go out and say, 'If we can do it in this environment, we can do another environment.' The big programs we've signed up in the last couple of years: we're a prime contractor to support the Navy C-40, which is a 737 derivative aircraft — we do heavy maintenance for that aircraft. We also do heavy maintenance on the Navy's fleet of P-8, which is another 737 derivative aircraft. Last year, we began work on a very large program for the Department of State. The Department of State actually has an entire air wing — not a lot of people know that — and their aircraft operate in austere environments like Afghanistan and Iraq, moving diplomats around. They outsource the entire operation of that fleet, and we are the prime contractor on that program. We provide the pilots, we provide the maintenance, we operate the aircraft. If they're going to go into a new location, we can actually build runways and infrastructure. We're really running this airline for the State Department. That's a very complicated skill set. We have over 900 people on that program. The other one that's exciting is that we also started last year as a prime contractor to the US Air Force to maintain landing gear. We have a great landing gear shop in Miami with incredible capability, and the Air Force selected us to provide landing gear support for over 800 aircraft in the inventory for the US Air Force. It's a big contract, a complicated contract with a lot of logistics involved, and it was the first of its kind for the Air Force. We were selected to be the prime contractor on that, so it's a real nice success recently.

That's right.

Certainly, there's some tooling and training investment that will be required, and we ultimately will do that in cooperation with the OEMs. A composite aircraft is going to be maintained differently than current aircraft. At AAR, we typically start to get active in a fleet when it's been out there for 10 years or more, when things are mature, the technology is available, the inventory is available. That's when we really start to push into a fleet. We've moved that up nicely over the last few years. For example, in our component support programs on the commercial side, we support Hawaiian Airlines' fleet of A320neos, which is obviously a new-generation aircraft. That's the first time we've supported an aircraft that's kind of brand new on the market in a complicated supply chain program, so we're proud of that and looking to do more on the component side. But going back to your question on maintaining them in the hangars, that work will be done differently once those aircraft are ready for maintenance.

Absolutely. That's a great question. A couple of thoughts there. First, it's important to highlight that AAR is the largest independent provider for what we do. There's no other company in aviation that offers the heavy maintenance, the part support, and the integrated supply chain programs for both commercial and government customers that is independent. All the competitors we have — very few compete in all of those areas at once, and any that do are either the OEMs like Airbus or Boeing, or part of an airline like Lufthansa or Air France. Our independence in that regard is very unique, and we believe it's an asset. If we think about the airline customer base, it's very important to them to have that independent solution available as an option. It keeps the market for these aftermarket services very healthy. With that in mind, we absolutely are seeing a longer-term view. This came up at our Investor Day last week in New York. Historically, if I think back a few years, it was very unusual to find a heavy maintenance contract that lasted more than one year. Typically, the airlines would move those aircraft around from provider to provider, largely driven by price. Price is still extremely important in that market, but the airlines are much more focused on longer-term agreements — three to five year agreements — to lock up hangar slots so they know they have a home for an aircraft. The key word there is 'home,' because it means a lot to the airline and a lot to us. If we get a long-term agreement, our mechanics know the expectations of that airline, they know the history of the aircraft. If you're working on a fleet for three to five years, chances are you're going to see the same aircraft more than once, so you have the history of the work we performed on it. That leads to better quality for the airline and better efficiency for us internally. That kind of shopping-the-market-every-year mentality is dissipating, and we see a lot more long-term thinking from our customers.

Most of our contracts with the DoD are long-term — five or ten years or more. They do think long-term. The other trend going on with the DoD is just more outsourcing in general, whether they're choosing to have a third party like us perform heavy maintenance on the fleet or buying used parts. That's something we've been talking about for a long time. AAR is the largest supplier of used airframe and engine parts in the world. We like to say that if the United States Air Force bought like a United or bought like a Delta, there would be billions and billions of dollars in savings if they were to employ more used part content in their engines and airframe builds. We're seeing signs that there's more openness to that. We see a lot of opportunity for savings for the government and certainly growth for us as a result of using more aftermarket parts content.

It's a gradual shift. There have been some awards and actions taken that suggest the government is more open to aftermarket content. The story tells itself when you go and say, 'If you used 30 or 40 percent aftermarket material in this engine build, you could save a million or two million dollars per overhaul on an engine.' A lot of people conflate used parts and PMAs all the time. A PMA is an aftermarket part, certainly form, fit, and function equivalent as designated by the FAA to an OEM part. But in our case, we're not talking about PMAs; we're just talking about a used OEM part that's been recertified. These are relatively straightforward decisions for the government to make. It's just a matter of telling the story and pointing out that the savings are there, and also that the material is available. That's really our core competency — being able to find aftermarket material better than any of our competitors to supply it for the government so they can realize the savings.

I think you hit it very well. AAR is such an interesting company because even though we're $2 billion and there are a lot of other companies much bigger than us, we touch every player in the market. We punch above our weight. When I think about the people I speak to — senior people whether it's with the government, commercial airlines, cargo carriers, or manufacturers — it's really amazing that we have so much reach across the industry given our size. But you pointed it out: we're playing lots of different angles at any one time. We can be a partner to an OEM, and we can be competing with them on a program. By and large, the OEMs recognize the value that AAR places in the aviation aftermarket supply chain. They realize there are nooks and crannies of the aftermarket that they cannot reach themselves, so there's a necessity for a company like AAR to exist to bring value to those corners and ultimately become an extension of the OEMs into the aftermarket. We've got some wonderful partnerships supporting our repair relationships. We've got some wonderful partnerships where we aggregate the spend from a particular airline because they want a nose-to-tail program, and we do nose-to-tail programs. That ultimately finds its way back to the OEMs, either through direct component repair spend or our buying piece part material from them to support work in our own shop. We also have a very large new parts distribution business, so we work with companies like Unison (a unit of GE), Eaton, or Northrop Grumman, where we're a factory new parts distributor. We work very hard to displace competitive product in the market and help them grow their market share.

Because of what we do — whether we're doing heavy maintenance on a thousand aircraft per year, supporting over a thousand aircraft on power-by-the-hour, or managing tens of thousands of parts each month on repair for various customers — we collect a lot of data and see a lot of what's going on in the aftermarket. That data, whether we share it directly or use it to price things, is very good for an OEM. For example, through our aftermarket parts trading business, if we know that this many engines are going to come on the market as surplus and be torn down, or we know that a number of different aircraft are going to be parted out, that supply of material on the market would be very interesting to an OEM because it may ultimately impact how much they decide to build themselves and how they allocate floor space. There's a lot of data we can provide in that regard.

It is. I talked about this at our Investor Day last week. We've got a number of different efforts designed to help sell the traditional businesses more effectively but also generate revenue on their own. We launched our first software program here recently called Evolution, which helps airlines repair manage their repair spend. We've also got an online parts store where you can fully transact and buy new parts through our parts store — it's one of the best options out there. Last year, we did $25 million of revenue through our digital channels. To see that kind of result after having only been at this for two years, we're excited about that and where it can take us. But it's easy to get overboard on digital and talk about blockchain and all these other things. We're certainly looking at that very carefully, but we're focused on very practical solutions that can enhance the stickiness of our revenue and the ease of transactions with our customers.

They are.

I've been at AAR for almost 18 years now. I accepted the job to come to the company the night of September 10th, 2001, and resigned my job the morning of 9/11. I joined AAR two weeks after that, and our revenues as a company basically went from $1 billion at the time down to about $600 million in less than nine months. To go from an industry that was really struggling when I joined it to where we are now has been a hell of a journey. The fundamentals, as you point out, are still extremely strong. On the airline side, a few of our customers last week announced earnings, and we saw new records come out of United and Delta. The OEMs — United Technologies and Lockheed Martin, for example — reported just today and had great performance. The performance of the industry remains very strong. The backlog of aircraft to be delivered is at an all-time high. I think it's a great time to be in aviation, and we are extremely well positioned in all of our markets to continue to grow and outpace the growth. AAR grew at 17% last year, which was certainly more than the market, and I feel good about our ability to do that in the years to come.

I don't see us adding more floor space in North America. Indianapolis alone is a 1.2 million square foot facility. We've got a lot of floor space in North America. Our constraint is not capacity in terms of facilities; our constraint, going back to that labor issue, is labor. Rockford, for example, which is a wonderful facility, we're working very hard to build a sustainable workforce there. We want to make that a success for a long time. Inside the walls we have, at least in North America, we're comfortable with that footprint. We want to grow inside that footprint. As we think about actual capacity expansion, I would see more of that happening overseas, particularly in Asia. We've got a joint venture in India, and we're working on building a facility over there with our partner. It's gone slower than we would have liked, but I think that's just the deal, and it's a long-term play. Whether we're a few months delayed now, I'm not as concerned. I'm more focused on the long term there for heavy maintenance. I also see opportunity in and around Asia for component repair. I don't think it's required to continue to grow over there because components can be shipped, and we're pretty good at logistics, so we can manage that. But over time, facilities in Asia and bringing AAR's know-how inside shops over there is something we'd like to do.

We have a significant presence in Europe. If you look at our commercial business, actually 40% of our commercial revenues come from outside the US, so we're already a pretty diversified company. Over time, you could see that reverse where the majority of revenues come from outside the US. Europe in particular — we've been in Europe for 40-plus years. We've got a great facility in Amsterdam where we do component repair. We've got a great program in the UK with our repair management business, Airinmar, in the UK. We have a great program with the UK MoD where we support their fleet of A400M aircraft. We've got sales offices with really talented teams in Paris and London. Our footprint in Europe is very strong. It's a very competitive market. As I mentioned, two of our biggest commercial competitors, Air France Industries and Lufthansa Technik, are headquartered there, so there's a lot of competition based there. But we compete very effectively, and we've got a very strong footprint there.

That's a great question. Certainly, we've gone through a lot of consolidation, and I think a certain amount of that is healthy. There have been several very, very large mergers announced of late. Your point is well taken: as some of these mega-mergers get done, there could be things that fall out of those mergers that are very interesting to us. The OEMs are focused on the next-generation platforms and supporting those platforms. To the extent that they want to exit certain current-generation or legacy platforms and use that workspace for the next big thing, I think that will create opportunities for us in terms of aftermarket support. We watch all that very closely. We've got great relationships with a number of the big OEMs, and I think ultimately that creates opportunities for us. But again, I come back to the point that it's important to both the commercial and government industry to have independent providers like AAR out there. The customers want it, they need it, and it keeps the market in a very healthy position. That's what we're focused on every day.

Thank you very much. We appreciate it, and we're focused on doing that again.

Hey, thank you for taking the time. We very much appreciate the interest.