AAR CORP. Form 10-Q Summary
Business context and reporting period
AAR CORP. reports two segments: Aviation Services, which includes aftermarket parts, supply-chain management and maintenance, repair and overhaul activities; and Expeditionary Services, which primarily manufactures pallets, shelters and containers for military customers. This unaudited report covers the three months ended August 31, 2022, the first quarter of fiscal 2023, compared with the prior-year quarter.
Financial performance and key metrics
| Metric | Quarter ended Aug. 31, 2022 | Quarter ended Aug. 31, 2021 |
|---|---|---|
| Sales | $446.3 million | $455.1 million |
| Operating income | $31.2 million | $15.1 million |
| Income from continuing operations | $22.3 million | $11.2 million |
| Net income | $22.7 million | $11.5 million |
| Diluted EPS | $0.63 | $0.32 |
| Net cash from operating activities | $6.8 million | $2.9 million |
- Gross profit increased to $81.9 million from $64.6 million, with an approximate consolidated gross margin of 18.4% versus 14.2%.
- Operating margin increased to approximately 7.0% from 3.3%. Net margin increased to approximately 5.1% from 2.5%.
- Continuing-operations operating cash flow was $7.0 million, down from $17.5 million, primarily because of increased working-capital investment, including a $26.0 million inventory increase.
- Total cash, cash equivalents and restricted cash declined to $48.4 million from $60.2 million at the prior-year quarter-end. Cash and cash equivalents were $44.3 million at August 31, 2022.
- Capital expenditures were $6.7 million, compared with $2.2 million in the prior-year quarter.
- Debt was $114.1 million net of debt issuance costs, compared with $98.9 million at May 31, 2022. Revolver borrowings were $115.0 million, with $473.7 million of availability after outstanding letters of credit.
- Working capital was $677.3 million. The company was in compliance with its financing covenants.
- Remaining performance obligations, or firm backlog, were approximately $820 million; about 40% was expected to be recognized as revenue over the next 12 months.
Material changes versus the prior comparable period
- Sales declined 1.9%, primarily because Aviation Services government and defense sales decreased $36.5 million, or 21.7%, following completion of certain government programs, including Afghanistan contracts.
- Commercial sales increased $26.3 million, or 9.8%, reflecting recovery in commercial passenger air traffic. Aviation Services commercial sales increased 9.3%, led by new-parts distribution and MRO activities.
- Aviation Services gross profit increased 28.1% to $78.0 million. Commercial gross margin rose to 18.3% from 11.4%, partly due to cost reductions and the absence of prior-year customer-contract termination charges.
- Expeditionary Services sales increased 14.4% to $22.3 million, while gross margin declined to 17.5% from 19.0% because of sales mix.
- The quarter included a favorable $2.9 million cumulative catch-up adjustment on long-term programs, compared with an unfavorable $1.0 million adjustment in the prior-year quarter.
- The prior-year quarter included $6.5 million of contract termination and asset impairment charges related to an early termination of a power-by-the-hour customer contract.
- The company repurchased 492,640 shares for $21.9 million during the quarter. Cumulative repurchases under the current authorization totaled $64.3 million through August 31, 2022, leaving approximately $85.7 million authorized.
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 as commercial aviation recovers and as commercial and government markets continue to offer growth opportunities. Risks include economic conditions, COVID-19 effects, public-policy decisions, airline-industry conditions, geopolitical events, government-program completion, foreign exchange, interest-rate fluctuations and customer credit risk.
- The company retained an uncapped performance guarantee related to an A220 contract after the buyer of its former Composites business entered bankruptcy. The customer alleges delivery failures and related losses. A loss is reasonably possible, but the company cannot estimate a loss range and states that the matter could materially affect operations, financial position and cash flows.
- In Russian bankruptcy litigation involving four engines, the company believes a loss is reasonably possible but cannot estimate the potential loss range. The alleged claim is approximately $13 million.
- The company continues to cooperate with government reviews relating to potential Foreign Corrupt Practices Act and other legal violations concerning activities in Nepal and South Africa; the potential outcome is not predictable.
- Remaining reserves related to minimum repair-volume guarantees on a component repair agreement totaled $3.1 million at August 31, 2022.
- The company had $6.2 million of deferred payroll taxes remaining under COVID-19 relief provisions, payable by December 31, 2022.
- The company sold $43.4 million of receivables under its receivables-financing agreement during the quarter. The agreement has a $150 million maximum and runs through February 22, 2023, subject to extension or earlier termination.
Most important facts for investors to verify
- Whether commercial aviation recovery offsets the decline in government and defense revenue.
- Whether improved Aviation Services margins are sustainable after the favorable cumulative catch-up adjustment and absence of prior-year unusual charges.
- Inventory growth, contract assets and working-capital requirements relative to operating cash flow.
- Revolver utilization, rising borrowing costs, covenant compliance and liquidity after share repurchases.
- The potential financial exposure from the A220 performance guarantee, Russian bankruptcy litigation and FCPA-related reviews.
- Timing and conversion of the $820 million firm backlog into revenue and cash flow.