AAR CORP. Form 10-K Summary
Reporting period: Fiscal year ended May 31, 2021. The provided filing is an annual Form 10-K, not a 2020 fourth-quarter filing; fiscal 2020 is the principal comparable period. AAR provides aviation aftermarket products and services and expeditionary products to commercial aviation, government, and defense customers.
Business Context
- Aviation Services: Parts supply, inventory management, aircraft and component maintenance, repair and overhaul, engineering, fleet management, and aircraft and engine sales and leasing; 94.0% of fiscal 2021 sales.
- Expeditionary Services: Transportation pallets, containers, shelters, and related engineering and integration services; 6.0% of sales.
- Government and defense sales increased in importance as commercial aviation remained depressed by COVID-19. U.S. government agencies and contractors represented $738.8 million, or 44.7% of consolidated sales, compared with 32.2% in fiscal 2020.
- Firm backlog was approximately $750 million at May 31, 2021; approximately 40% was expected to convert to revenue within 12 months.
Financial Performance
| Metric ($ millions, except per share data) | FY2021 | FY2020 | Change |
|---|---|---|---|
| Sales | $1,652.3 | $2,072.0 | (20.3%) |
| Gross profit | $275.9 | $269.2 | 2.5% |
| Gross margin | 16.7% | 13.0% | +3.7 pts |
| Operating income | $85.2 | $41.3 | 106.3% |
| Operating margin | 5.2% | 2.0% | +3.2 pts |
| Income from continuing operations | $46.3 | $24.8 | 86.7% |
| Net income | $35.8 | $4.4 | Substantial increase |
| Diluted EPS | $1.00 | $0.13 | Increase |
| Cash flow from continuing operations | $108.5 | $(19.1) | +$127.6 |
Commercial sales declined 37.6%, or $486.8 million, while government and defense sales increased 8.6%, or $67.1 million. Aviation Services sales decreased 20.9% to $1,553.7 million, while segment gross profit declined only 1.5% to $263.2 million. Expeditionary Services sales decreased 8.5% to $98.6 million, but gross profit increased to $12.7 million from $1.9 million following the divestiture of the loss-making Composites business.
Gross margin benefited from $53.8 million of government workforce subsidies, including CARES Act and foreign-government support. Selling, general and administrative expense decreased $38.2 million to $182.4 million, although SG&A as a percentage of sales increased to 11.0% from 10.6% because sales declined faster than expenses. The effective tax rate on continuing operations rose to 28.2% from 18.4%.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Cash flow from continuing operating activities was $108.5 million, driven by a $74.9 million inventory reduction and CARES Act proceeds, partly offset by a $25.0 million Unison license fee and timing of long-term program collections and payments.
- Capital expenditures were $11.3 million, compared with $23.6 million in fiscal 2020. Investing cash use was $0.5 million.
- Financing cash use was $469.5 million, primarily reflecting repayment of precautionary Revolving Credit Facility borrowings drawn in fiscal 2020.
- Cash and cash equivalents were $51.8 million, plus $8.4 million of restricted cash, at May 31, 2021, versus total cash and restricted cash of $424.7 million a year earlier.
- Total debt was $135.2 million, including $109.5 million drawn under the $600 million Revolving Credit Facility and a $25.7 million Canadian term loan. Revolver availability was $471.3 million after outstanding letters of credit.
- Total assets declined to $1,539.7 million from $2,079.0 million, mainly reflecting lower cash and inventory. Equity increased to $974.4 million from $902.6 million.
- Management stated that all financing covenants were satisfied at May 31, 2021. The Canadian term loan matures November 1, 2021 and management intends to refinance it using the Revolving Credit Facility.
Material Changes and Unusual Items
- COVID-19 caused the major commercial revenue decline and led to facility consolidations, contract exits or restructurings, reduced discretionary spending, workforce reductions, and other cost actions.
- AAR received $57.2 million under the CARES Act Payroll Support Program, including a $48.5 million grant recognized as a reduction of expenses and an $8.7 million promissory note that was repaid in fiscal 2021. The grant and other subsidies materially supported reported commercial gross margin.
- AAR sold its Composites business on August 31, 2020 and recorded a $20.2 million loss. Potential contingent consideration is up to $6.5 million.
- Discontinued operations generated a $10.5 million loss, including an $11.0 million charge related to the Department of Justice settlement of the former COCO business investigation. The reserve for the matter was $12.7 million at year-end.
- A former commercial power-by-the-hour customer notified AAR in June 2021 of an earlier-than-expected termination; management expected $5 million to $10 million of contract-asset and rotable-asset impairment charges in the first quarter of fiscal 2022.
- Fiscal 2021 included $9.1 million of impairment charges, including $5.8 million on rotable assets supporting long-term programs and $2.6 million related to Expeditionary Services facility consolidation.
- Net favorable cumulative catch-up adjustments on long-term programs were $12.0 million, compared with $3.9 million in fiscal 2020.
Outlook and Principal Risks
Management expects long-term commercial aviation aftermarket trends to remain favorable and sees continued growth in government businesses and recovery in some commercial markets. AAR intends to focus on core aviation services, improve operating efficiency, invest selectively, and pursue higher returns on capital. No quantitative fiscal 2022 revenue or earnings guidance is provided in the filing.
- Commercial aviation recovery remains uncertain, including passenger and business travel levels, aircraft utilization, airline financial health, fleet retirements, and future infectious-disease disruptions.
- Government exposure creates risks from appropriations, procurement decisions, competitive bidding, contract options, terminations for convenience, sequestration, and changes in defense priorities.
- Fixed-price and long-term contracts depend on estimates of costs, flight hours, labor, repairs, penalties, and incentives; unfavorable estimate changes could reduce profitability.
- Key risks include skilled-labor shortages, supplier and subcontractor failures, cybersecurity incidents, international operations, regulatory or certification actions, asset and inventory impairments, customer credit losses, and interest-rate or LIBOR transition effects.
- CARES Act restrictions prohibited dividends and share repurchases through September 30, 2021 and limited certain employee compensation through March 24, 2022.
- Potential Foreign Corrupt Practices Act matters involving Nepal and South Africa were self-reported to U.S. and UK authorities; the filing states that the ultimate actions, if any, cannot currently be predicted.
Investor Verification Checklist
- Verify the pace of commercial aviation recovery and whether sales and margins can improve without recurring government subsidies.
- Reconcile reported profitability with the $53.8 million of government workforce subsidies and other unusual items.
- Monitor the expected $5 million to $10 million fiscal 2022 impairment charge from the early contract termination.
- Assess government-contract concentration, backlog conversion, renewal rates, and exposure to budget or appropriation changes.
- Confirm refinancing of the $25.7 million Canadian term loan and continued compliance with credit-facility covenants.
- Review the DOJ settlement, remaining COCO liabilities, and unresolved FCPA-related investigations.
- Evaluate inventory and rotable-asset recoverability, particularly for aircraft types with reduced utilization or declining demand.