AAR CORP. Form 10-Q Summary
Reporting period: Quarter and nine months ended February 28, 2021; fiscal year ending May 31. The filing is unaudited. AAR operates through Aviation Services, including supply-chain and MRO activities, and Expeditionary Services, primarily manufacturing activities.
Financial performance and key metrics
| Metric | Q3 FY2021 | Q3 FY2020 | 9M FY2021 | 9M FY2020 |
|---|---|---|---|---|
| Sales | $410.3 million | $553.1 million | $1,214.7 million | $1,655.5 million |
| Operating income | $39.7 million | $5.3 million | $64.5 million | $56.2 million |
| Income from continuing operations | $31.1 million | $2.6 million | $31.6 million | $39.8 million |
| Net income | $28.1 million | $2.3 million | $21.8 million | $20.9 million |
| Diluted EPS | $0.79 | $0.06 | $0.61 | $0.59 |
| Operating margin | 9.7% | 1.0% | 5.3% | 3.4% |
- Q3 sales declined 25.8%, while nine-month sales declined 26.6%, primarily because COVID-19 sharply reduced commercial aviation activity.
- Aviation Services sales decreased 26.5% in Q3 and 27.7% for nine months. Commercial sales fell 42.1% in Q3 and 46.2% for nine months, while government and defense sales increased 4.8% and 9.9%, respectively.
- Expeditionary Services sales declined 9.6% in Q3 and 6.1% for nine months, largely reflecting the sale of the Composites business.
- Consolidated gross profit was $86.0 million in Q3, versus $65.3 million in the prior-year quarter, producing an estimated gross margin of 21.0% versus 11.8%. For nine months, gross profit was $204.1 million versus $232.8 million, with estimated margins of 16.8% and 14.1%, respectively.
- Q3 SG&A declined 22.7% to $44.9 million, but increased to 10.9% of sales from 10.5% because sales declined faster than expenses.
Cash flow, balance sheet, debt and liquidity
- Cash provided by operating activities was $82.6 million for nine months, including $85.0 million from continuing operations, compared with $8.9 million of total operating cash used in the prior-year period.
- Operating cash flow benefited from inventory reductions and $48.5 million of CARES Act Payroll Support Program grants, partially offset by a $25.0 million Unison license payment.
- Investing activities provided $2.3 million from continuing operations, compared with $20.0 million used in the prior-year period. The change included $10.0 million of proceeds from terminated split-dollar life insurance policies and lower capital expenditures.
- Financing activities used $397.2 million from continuing operations, primarily reflecting repayment of the precautionary revolving-credit draw taken in fiscal 2020.
- At February 28, 2021, cash and cash equivalents were $99.2 million and restricted cash was $13.4 million. Total cash, cash equivalents and restricted cash were $112.6 million.
- Working capital was $640.7 million. Total debt was $207.6 million before $1.6 million of debt issuance costs, compared with $602.0 million before costs at May 31, 2020.
- The $600 million revolving credit facility had $174.5 million outstanding and approximately $20.3 million of letters of credit, leaving reported availability of $405.2 million. The facility matures September 25, 2024. A $24.3 million term loan is due November 1, 2021, and the Payroll Support Program note had a carrying amount of $8.8 million.
- AAR was in compliance with its financing covenants at February 28, 2021. The filing also reports $11.6 million of other outstanding letters of credit and $10.2 million of foreign credit lines.
Material changes versus the prior comparable period
- Commercial aviation remained materially depressed because of COVID-19 and reduced passenger flight hours. Management implemented hiring, compensation, spending, furlough, workforce-reduction, facility-closure and contract-restructuring measures.
- Government and defense demand increased, supported by recently awarded contracts, partly offsetting the commercial decline.
- AAR sold its Composites business on August 31, 2020, recognizing a $19.5 million loss. The transaction included $1.0 million of net cash proceeds and potential earn-out consideration of up to $6.5 million based on sales targets.
- The company recognized $52.3 million of government workforce subsidies in gross profit for the nine-month period, including the CARES Act grant and foreign-government subsidies. These subsidies materially supported reported margins.
- Nine-month results included $7.0 million of impairment charges, $8.3 million of severance and furlough-related costs, a $1.2 million inventory reserve for an exited product line, and a $4.5 million charge for minimum repair-volume guarantees.
- Net contract assets changed from a $27.5 million net contract liability at May 31, 2020 to a $47.7 million net contract asset at February 28, 2021, primarily due to timing differences between performance, billing and collections.
- Remaining performance obligations were approximately $700 million, with approximately 50% expected to be recognized over the next 12 months.
Outlook, risks, contingencies and unusual items
- Management expects long-term strength in Aviation Services and favorable commercial aftermarket trends, but commercial recovery remains uncertain and depends on aircraft utilization, passenger traffic, fleet decisions and COVID-19 developments. Vaccine distribution was cited as a potential driver of recovery.
- Commercial aviation volumes and flight hours remain a central operating risk. Other risks include government-contract execution, supply-chain and MRO demand, interest rates, foreign exchange, credit losses, financing-market conditions and covenant compliance.
- AAR recognized a $3.0 million Q3 loss from discontinued operations and a $9.8 million nine-month loss. These results included increased reserves relating to a tentative settlement with the Department of Justice concerning alleged False Claims Act issues at Airlift Group.
- The tentative DOJ settlement is approximately $11.5 million, subject to a definitive agreement and other contingencies. A $12.8 million reserve, including legal fees, was recorded at February 28, 2021. If not finalized, the DOJ and qui tam plaintiff could pursue litigation, including potential treble damages and penalties.
- The company continues to cooperate with government reviews concerning self-reported potential Foreign Corrupt Practices Act and other legal violations related to activities in Nepal and South Africa. The filing states that the potential outcome cannot currently be predicted.
- The CARES Act promissory note carries restrictions for approximately two years, including limitations on dividends, share repurchases, employee compensation and certain workforce actions.
- AAR had no material change to the risk factors reported in its fiscal 2020 Form 10-K. Management concluded that disclosure controls and procedures were effective as of February 28, 2021.
Important facts for investors to verify
- Whether commercial aviation activity and flight hours recover sufficiently to support Aviation Services revenue and margins without continued government subsidies.
- The sustainability of reported profitability after excluding CARES Act and foreign-government workforce subsidies, divestiture effects and other unusual items.
- The final terms and timing of the DOJ settlement, the adequacy of the $12.8 million reserve and the status of the Nepal and South Africa investigations.
- Refinancing or repayment plans for the $24.3 million term loan due November 1, 2021 and compliance with revolving-credit covenants.
- Collections on past-due receivables of $6.5 million from former commercial program customers, net of an $8.7 million allowance.
- The conversion and timing of the approximately $700 million backlog into revenue and cash flow, including customer options and long-term program assumptions.