AAR CORP. Form 10-Q Summary
Reporting period: Three months ended August 31, 2021, the first quarter of fiscal 2022. The filing was signed September 23, 2021. Results are unaudited and should be read with the fiscal 2021 Form 10-K.
Business Context
AAR operates through two reportable segments: Aviation Services, which provides aftermarket parts, supply-chain management, logistics, and MRO services; and Expeditionary Services, which manufactures pallets, shelters, containers, and related systems for military customers.
Commercial aviation activity partially recovered from COVID-19 disruption. The company also concluded its activities in Afghanistan following the U.S. government withdrawal; Afghanistan-related operations generated approximately $67 million of fiscal 2021 revenue.
Financial Performance and Position
| Metric | Q1 FY2022 | Q1 FY2021 | Change |
|---|---|---|---|
| Sales | $455.1 million | $400.8 million | 13.5% increase |
| Gross profit | $64.6 million | $48.6 million | 32.9% increase |
| Gross margin | 14.2% | 12.1% | Up approximately 210 basis points |
| Operating income | $15.1 million | $3.2 million | Increase of $11.9 million |
| Operating margin | 3.3% | 0.8% | Improved |
| Income from continuing operations | $11.2 million | $(13.9) million | Returned to profitability |
| Net income | $11.5 million | $(14.5) million | Returned to profitability |
| Diluted EPS | $0.32 | $(0.42) | Improved by $0.74 |
| Operating cash flow | $2.9 million | $38.9 million | Decrease of $36.0 million |
Continuing-operations operating cash flow was $17.5 million versus $39.8 million in the prior-year quarter. The decrease primarily reflected the prior-year $48.5 million CARES Act payroll grant, partly offset by the prior-year $25.0 million Unison license-fee payment. Discontinued operations used $14.6 million of cash, primarily due to payment of the Department of Justice settlement.
- Aviation Services: Sales rose 19.8% to $435.6 million and gross profit increased 36.5% to $60.9 million. Commercial sales increased 57.5% to $267.2 million, while government and defense sales declined 13.2% to $168.4 million.
- Expeditionary Services: Sales declined 47.6% to $19.5 million and gross profit declined 7.5% to $3.7 million. Gross margin nevertheless increased to 19.0% from 10.8%, primarily because the prior-year period included the unprofitable Composites business, which was sold on August 31, 2020.
- SG&A: Increased 8.8% to $49.3 million, but declined to 10.8% of sales from 11.3%.
- Balance sheet: Cash and cash equivalents were $48.8 million at August 31, 2021, compared with $51.8 million at May 31, 2021. Working capital was $620.7 million. Inventories were $525.8 million, down from $540.6 million.
- Debt and liquidity: Long-term debt was $127.6 million, including $104.5 million drawn on the $600 million revolving credit facility and $24.5 million on a term loan due November 1, 2021. Revolver availability was approximately $482.9 million after $12.6 million of letters of credit. The company reported compliance with all financial and other covenants.
- Receivables program: The company sold $87.5 million of receivables during the quarter under a program capped at $150 million. Restricted cash related to collections not yet remitted to the purchaser was $3.8 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven by commercial aviation recovery, including higher MRO and aftermarket parts activity. Commercial sales increased $92.0 million, or 52.5%, while government sales decreased $37.7 million, or 16.7%.
- Profitability improved substantially because of higher Aviation Services volume, better commercial and government gross margins, cost-reduction actions, and the absence of the prior-year $19.5 million loss on the sale of the Composites business.
- The quarter included a $2.3 million impairment charge related to rotable assets and an unfavorable $1.0 million cumulative catch-up adjustment on long-term programs. A customer’s early termination of a commercial power-by-the-hour contract resulted in a $5.2 million charge, including $4.2 million of loss reserves.
- The company recorded an additional $1.7 million obligation for minimum repair-volume guarantees under an outsourced component-repair agreement. Remaining reserves for this obligation were $4.6 million at August 31, 2021.
- Cash flow was lower than the prior year because the prior-year period benefited from CARES Act support. Financing cash usage was only $5.5 million compared with $347.9 million in the prior-year period, when the company repaid a substantial revolving-credit draw.
Guidance, Outlook, Risks, and Unusual Items
Management did not provide specific quantitative earnings or revenue guidance in the filing. Management expects long-term strength in Aviation Services and views commercial and government growth trends as favorable, while emphasizing continued investment and growth opportunities.
- Commercial and government operations remain exposed to COVID-19, airline traffic, economic conditions, public policy, geopolitical events, and changes in government contracting.
- The Afghanistan withdrawal ended certain U.S. Department of Defense and WASS activities and may reduce government-related revenue.
- Remaining performance obligations, or firm backlog, were approximately $760 million at August 31, 2021. Approximately 50% was expected to convert to revenue over the following 12 months, with approximately 50% of the remainder expected over the next three years.
- The company settled a Department of Justice False Claims Act investigation for approximately $11.5 million, paid in the quarter, without admitting wrongdoing. The matter was reported in discontinued operations.
- The company continues to cooperate with U.S. and U.K. authorities regarding self-reported potential Foreign Corrupt Practices Act and other legal violations involving activities in Nepal and South Africa. The filing states that the potential outcome cannot currently be predicted.
- Forward-looking results depend on estimates for long-term contracts, labor and overhead costs, customer demand, contract profitability, and timing of deliveries. Actual results may differ materially.
Important Facts for Investors to Verify
- Whether the commercial aviation recovery continues and offsets lower government and defense activity.
- The timing and refinancing or repayment of the $24.5 million term loan due November 1, 2021.
- Future cash conversion, including working-capital requirements, receivables sales, inventory levels, and discontinued-operation obligations.
- The ultimate cost and cash impact of PBH contract terminations, minimum-volume guarantees, impairment charges, and long-term program estimates.
- Potential outcomes of the ongoing Foreign Corrupt Practices Act-related reviews.
- Conversion of the $760 million backlog into revenue and the related profitability of long-term programs.
- Effects of the Afghanistan exit and other government contract volume changes.