AAR CORP. Fiscal 2020 Form 10-K Summary
Business context and reporting period
This filing is an annual report for the fiscal year ended May 31, 2020, rather than a 2019 fourth-quarter filing. AAR provides aviation aftermarket products and services and government and defense solutions through Aviation Services and Expeditionary Services. Aviation Services represented approximately 95% of fiscal 2020 sales.
- Fiscal 2020 results include the initial COVID-19 impact, particularly during the fourth quarter.
- At May 31, 2020, AAR had approximately 5,400 employees, including approximately 1,200 furloughed due to COVID-19.
- Firm backlog was approximately $1.0 billion; approximately 50% was expected to be recognized over the following 12 months.
Financial performance and position
| Metric | Fiscal 2020 | Fiscal 2019 | Change |
|---|---|---|---|
| Sales | $2,072.0 million | $2,051.8 million | 1.0% increase |
| Gross profit | $269.2 million | $329.8 million | 18.4% decrease |
| Gross margin | 13.0% | 16.1% | Down approximately 3.1 points |
| Operating income | $41.3 million | $98.3 million | 57.9% decrease |
| Operating margin | 2.0% | 4.8% | Down approximately 2.8 points |
| Income from continuing operations | $24.8 million | $84.1 million | 70.5% decrease |
| Net income | $4.4 million | $7.5 million | Decrease |
| Diluted EPS | $0.13 | $0.21 | Decrease |
| Cash flow from continuing operations | $(19.1) million | $60.5 million | Decrease of $79.6 million |
- Aviation Services sales increased 2.3% to $1,964.2 million. Government and defense sales rose 20.2% to $695.3 million, while commercial sales fell 5.5% to $1,268.9 million.
- Expeditionary Services sales declined 17.8% to $107.8 million, and gross profit fell to $1.9 million from $16.2 million.
- Government and defense customers accounted for $778.8 million, or 37.6% of consolidated sales. U.S. government agencies and contractors accounted for $668.2 million, or 32.2%.
- Cash and cash equivalents were $404.7 million at May 31, 2020, compared with $21.3 million a year earlier. Total liquidity including restricted cash was $424.7 million.
- Total debt increased to $602.0 million from $142.9 million, principally because AAR drew substantially on its revolving credit facility as a COVID-19 precaution. Revolver borrowings were $579.5 million, with approximately $19.9 million of letters of credit, leaving approximately $0.6 million of availability.
- Working capital increased to $1,055.6 million from $595.0 million, while inventories increased to $623.1 million from $523.7 million.
- Capital expenditures were $23.6 million, compared with $17.4 million in fiscal 2019.
Material changes versus the prior comparable period
- Commercial aviation demand deteriorated sharply in the fourth quarter as COVID-19 reduced aircraft utilization and flight hours. Fourth-quarter sales were $416.5 million versus $562.7 million in the prior-year quarter, and the quarter produced a $14.9 million operating loss.
- AAR recorded $31.3 million of contract termination and restructuring charges on certain commercial power-by-the-hour contracts, including a $17.3 million revenue reduction, $5.4 million of forward loss reserves and $8.6 million of other charges.
- Additional fiscal 2020 charges included $11.0 million of impairment charges related to product-line exits, $4.9 million for facility closures and $5.0 million of severance and furlough costs. AAR closed its Duluth airframe maintenance facility and exited other underperforming contracts and assets.
- Government and defense growth partly offset the commercial decline, supported by new awards including a $118 million Naval Air Systems Command contract for two C-40 aircraft.
- The COCO business exit was completed. Loss from discontinued operations improved to $20.4 million from $76.6 million, primarily because prior-year COCO impairment charges were substantially higher.
- AAR adopted ASC 842 lease accounting on June 1, 2019, recognizing operating lease right-of-use assets of $123.2 million and lease liabilities of $116.8 million at adoption. The adoption did not materially affect operations or cash flows.
- Previously reported internal-control material weaknesses related to inventory counting, information technology general controls and vendor payment information were reported as remediated as of May 31, 2020.
Outlook, commentary, risks and unusual items
- Management expects long-term Aviation Services demand to benefit from value-added offerings to commercial and government customers, but acknowledged substantial uncertainty regarding commercial fleet structures and the pace of recovery.
- COVID-19 created material risks to demand, liquidity, collections, supply chains, staffing and facility utilization. The filing does not provide formal fiscal 2021 revenue or earnings guidance.
- Certain subsidiaries expected to receive $57.2 million under the CARES Act Payroll Support Program, consisting of approximately $48.5 million of grants and $8.7 million of a low-interest, 10-year senior unsecured note. Receipt and final terms were not assured as of the filing date.
- Expected CARES Act restrictions included limitations on involuntary terminations, furloughs and pay reductions through September 30, 2020; restrictions on dividends and share repurchases through September 30, 2021; and compensation limitations through March 24, 2022.
- AAR entered into an agreement on June 23, 2020 to sell its Composites business. The filing anticipated an approximately $20 million impairment charge in the first quarter of fiscal 2021, subject to closing and other conditions.
- AAR was in compliance with its financing covenants at May 31, 2020. Key obligations included $602.0 million of bank borrowings, $99.2 million of undiscounted operating lease payments and $366.2 million of purchase obligations, predominantly due in fiscal 2021.
- A Department of Justice investigation under the civil False Claims Act involving AAR Airlift Group remained unresolved. Management believed a loss was probable but could not reasonably estimate the maximum potential loss or determine whether the exposure could be material.
- The Company self-reported potential Foreign Corrupt Practices Act and other legal violations relating to activities in Nepal and South Africa; agency reviews were ongoing and the outcome was not predictable.
- The pension obligation exceeded plan assets by $27.3 million at May 31, 2020. Expected fiscal 2021 pension contributions were approximately $3.1 million.
Most important facts for investors to verify
- Confirm the effect and duration of COVID-19 on commercial aviation volumes, MRO demand, commercial contract profitability and the pace of workforce restoration.
- Monitor liquidity after the near-full draw on the $600 million revolving facility, including covenant compliance, debt maturities and the limited remaining revolver availability.
- Verify the timing, final terms and restrictions associated with the anticipated $57.2 million CARES Act support.
- Assess inventory recoverability, particularly the $623.1 million inventory balance, given lower aircraft utilization and the filing’s reliance on demand and recovery-rate estimates.
- Track the approximately $20 million expected fiscal 2021 impairment and closing status of the Composites divestiture.
- Review developments in the DOJ False Claims Act investigation and the self-reported potential foreign bribery matters, for which the ultimate exposure was not clearly quantifiable.
- Reconcile reported earnings with unusual contract, restructuring, impairment and discontinued-operation charges when evaluating underlying profitability.