AAR CORP. Fiscal 2024 First-Quarter 10-Q Summary
Business context and reporting period
AAR CORP. reported results for the three months ended August 31, 2023, the first quarter of fiscal 2024. AAR provides aviation aftermarket products and services through Parts Supply, Repair & Engineering, Integrated Solutions, and Expeditionary Services. The financial statements are unaudited and should be read with the fiscal 2023 Form 10-K.
During the quarter, management reorganized the former Aviation Services segment into Parts Supply, Repair & Engineering, and Integrated Solutions. Prior-period segment information was recast; the change did not affect consolidated results.
Financial performance and key metrics
| Metric | Q1 FY2024 | Q1 FY2023 | Change |
|---|---|---|---|
| Sales | $549.7 million | $446.3 million | Up 23.2% |
| Gross profit | $101.3 million | $81.9 million | Up 23.7% |
| Gross margin | 18.4% | 18.4% | Flat |
| Operating income | $25.3 million | $31.2 million | Down 18.9% |
| Operating margin | Approximately 4.6% | Approximately 7.0% | Down |
| Income from continuing operations | $(0.6) million | $22.3 million | Declined |
| Net income | $(0.6) million | $22.7 million | Declined |
| Diluted EPS | $(0.02) | $0.63 | Declined |
- Commercial sales increased 33.7% to $392.5 million, driven primarily by strong demand and volume growth in Parts Supply. Government and defense sales increased 2.9% to $157.2 million.
- Commercial gross margin improved to 19.3% from 18.2%, while government and defense gross margin declined to 16.3% from 18.6% due primarily to product and service mix.
- Segment sales and operating income were: Parts Supply, $236.8 million and $15.1 million; Repair & Engineering, $137.5 million and $9.1 million; Integrated Solutions, $156.3 million and $7.7 million; and Expeditionary Services, $19.1 million and $1.3 million.
- SG&A increased 49.1% to $74.7 million, including an $11.2 million charge related to an unfavorable Russian court judgment and $2.8 million of Trax acquisition and amortization expenses.
- Interest expense increased to $5.8 million from $1.1 million. The average borrowing rate increased to 6.47% from 2.64%, and borrowings were higher following business investments including the Trax acquisition.
- Cash used in operating activities was $18.5 million, compared with $7.0 million of cash provided in the prior-year quarter, primarily due to increased inventory investment and working-capital requirements.
- Cash used in investing activities was $11.6 million, including $9.1 million of capital expenditures. Financing activities provided $38.7 million, primarily from $35.0 million of net revolving-credit borrowings.
- Cash, cash equivalents, and restricted cash totaled $90.2 million at August 31, 2023, including $70.3 million of unrestricted cash and $19.9 million of restricted cash.
- Working capital was $813.7 million. Inventories increased to $614.2 million from $574.1 million at May 31, 2023, while accounts receivable increased to $280.6 million from $241.3 million.
- Revolving-credit borrowings were $307.0 million, net long-term debt was $304.8 million, and approximately $301.9 million of revolving-facility availability remained after outstanding letters of credit. The company was in compliance with its debt covenants.
- Remaining performance obligations were approximately $810 million, with approximately 55% expected to be recognized as revenue within 12 months and approximately 45% of the remainder over the following three years.
Material changes versus the prior comparable period
- Revenue growth accelerated, particularly in commercial Parts Supply, but operating income declined because of the $11.2 million Russian judgment charge, higher corporate and growth-related expenses, and increased interest costs.
- AAR recorded a $26.7 million non-cash, pre-tax pension settlement charge, or $16.1 million after tax, after settling future obligations under its frozen U.S. defined benefit plan. This charge materially affected net income but did not require additional company cash contributions.
- Operating cash flow shifted from a $7.0 million inflow to an $18.5 million outflow as inventory, receivables, and contract assets increased.
- Parts Supply revenue rose 40.5%, but segment operating margin fell to 6.4% from 10.9%, primarily because of the Russian judgment charge. Repair & Engineering margin improved to 6.6% from 5.8%; Integrated Solutions margin declined to 4.9% from 6.5%; and Expeditionary Services margin declined to 6.8% from 10.3%.
- Trax, acquired on March 20, 2023, added software and fleet-management capabilities to Integrated Solutions. The acquisition consideration was $120.0 million plus potential contingent consideration of up to $20.0 million.
- No share repurchases occurred during the quarter, compared with $21.9 million of repurchases in the prior-year quarter.
Guidance, outlook, risks, contingencies, and unusual items
Management did not provide specific quarterly or full-year financial guidance in the filing. Management stated that long-term aviation products and services demand is expected to remain strong, commercial aftermarket growth trends are favorable, and the company intends to invest in commercial and government opportunities.
- The company recognized a total $13.0 million liability related to Russian bankruptcy litigation. It disputes the Russian appellate judgment, may seek further review, and stated that sanctions and trade restrictions could limit its ability to satisfy or settle the judgment.
- A customer has asserted a performance-guarantee claim related to the former Composites business and an A220 contract, seeking at least $32 million. AAR disputes the claim and believes it has defenses, but states that a loss is reasonably possible and the range of loss cannot currently be estimated.
- AAR continues to cooperate with U.S. and U.K. authorities concerning self-reported potential Foreign Corrupt Practices Act and other legal violations involving Nepal and South Africa. The potential outcome is not predictable.
- AAR has a $9.7 million guarantee liability for 40% of the debt of its Indian joint venture and is evaluating a potential exit from that investment. The joint venture generated a $0.6 million loss attributable to AAR during the quarter.
- The company retained $5.1 million of reserves related to minimum repair-volume guarantees under a component-repair outsourcing agreement.
- Market risks include variable interest rates, foreign exchange movements, and credit losses. A hypothetical 10% U.S. dollar devaluation against foreign currencies was not expected to have a material impact for the quarter.
- Management reported effective disclosure controls and no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether commercial aftermarket demand and Parts Supply volume growth continue without further margin pressure.
- The cash-flow impact of elevated inventory, receivables, and contract assets, and whether operating cash flow returns to positive levels.
- Debt reduction, interest-rate exposure, covenant compliance, and remaining revolving-credit capacity.
- The ultimate resolution and enforceability of the $13.0 million Russian judgment and the related sanctions issues.
- The potential financial exposure from the uncapped A220 performance guarantee and the customer’s claim for at least $32 million.
- Integration results, contingent compensation costs, and revenue growth from the Trax acquisition.
- Any additional changes in cumulative catch-up adjustments, contract estimates, or loss reserves on long-term programs.