AAR CORP. Form 10-Q Summary
Reporting period: Quarter and six months ended November 30, 2022; fiscal 2023 second quarter. The financial statements are unaudited. AAR reports Aviation Services and Expeditionary Services. Prior-period comparisons are for the quarter and six months ended November 30, 2021.
Key Financial Metrics
| Metric | Q2 FY2023 | Q2 FY2022 | Six months FY2023 | Six months FY2022 |
|---|---|---|---|---|
| Sales | $469.8 million | $436.6 million | $916.1 million | $891.7 million |
| Operating income | $32.4 million | $30.1 million | $63.6 million | $45.2 million |
| Income from continuing operations | $22.5 million | $20.8 million | $44.8 million | $32.0 million |
| Net income | $22.5 million | $20.8 million | $45.2 million | $32.3 million |
| Diluted EPS | $0.64 | $0.58 | $1.27 | $0.90 |
| Operating cash flow | Not separately provided | Not separately provided | $(39.3) million total | $19.2 million total |
- Q2 consolidated gross profit was $85.8 million, or approximately 18.3% of sales, compared with $78.4 million, or approximately 18.0%, in the prior-year quarter.
- Q2 operating margin was approximately 6.9%; net margin was approximately 4.8%. For the six-month periods, operating margin was approximately 6.9% versus 5.1%, and net margin was approximately 4.9% versus 3.6%.
- At November 30, 2022, cash and cash equivalents were $49.0 million and restricted cash was $2.2 million. Working capital was $736.6 million, inclusive of cash of $51.2 million.
- Long-term debt was $197.2 million, up from $98.9 million at May 31, 2022. Revolving-credit borrowings were $198.0 million, with approximately $11.2 million of letters of credit and reported availability of $390.8 million under the then-existing facility.
- Total assets were $1.647 billion and total equity was $1.035 billion at November 30, 2022.
- Six-month operating cash flow from continuing operations was negative $38.9 million versus positive $33.4 million in the prior-year period. Investing cash flow was negative $18.3 million, while financing cash flow was positive $50.0 million.
Material Changes Versus Prior Comparable Period
- Q2 sales increased 7.6%, driven primarily by Aviation Services sales growth of 6.3%. Commercial-customer sales increased 21.0% as commercial passenger air traffic continued recovering from COVID-19.
- Government and defense sales decreased 11.7% in the quarter and 19.1% for the six-month period, primarily because certain government programs, including Afghanistan contracts, were completed.
- Aviation Services gross profit increased 11.2% in Q2 and 18.8% for the six-month period. Commercial Aviation Services gross margin increased to 18.4% from 17.4% in Q2 and to 18.4% from 14.3% for the six-month period.
- Expeditionary Services sales increased 39.3% in Q2, but gross profit decreased 20.5%. Its gross margin declined to 14.5% from 25.4% because of a shift toward lower-margin product lines.
- SG&A increased 12.1% in Q2 and 6.7% for the six-month period, reflecting investments to support sales growth; SG&A was 11.2% of sales versus 10.8% in the prior-year periods.
- Interest expense increased to $2.1 million in Q2 from $0.5 million and to $3.2 million for the six-month period from $1.2 million, reflecting higher borrowings and interest rates.
- Cash flow deteriorated primarily because of an $18.0 million Unison license-fee payment and increased inventory investment to support expected growth in aftermarket trading activities.
- Inventories increased to $595.0 million from $550.5 million at May 31, 2022, while accounts receivable increased to $225.3 million from $214.0 million.
- The company repurchased 1.2 million shares for $50.1 million during the six-month period. Since renewal of the authorization, cumulative repurchases totaled $92.4 million against a $150 million authorization.
Outlook, Liquidity, Risks, and Unusual Items
- Management expects long-term strength in Aviation Services, supported by commercial aviation recovery and demand from commercial and government customers. No quantitative earnings or revenue guidance is provided in the filing.
- Remaining performance obligations, or firm backlog, were approximately $765 million at November 30, 2022. Management expects approximately 35% to convert to revenue within 12 months and approximately 55% within three years.
- On December 14, 2022, after the reporting date, AAR entered into a new $620 million unsecured revolving credit facility expiring December 14, 2027, with potential commitments of up to $920 million. Existing borrowings rolled into the new facility.
- Financing arrangements require leverage and interest-coverage compliance and contain other covenants. AAR stated that it was in compliance with its covenants at November 30, 2022.
- Net favorable cumulative catch-up adjustments were $2.9 million in Q2 and $5.8 million for the six-month period, compared with $5.9 million and $4.9 million, respectively, in the prior-year periods.
- AAR retained a performance guarantee related to an A220 contract following the sale of its Composites business. The customer has asserted potential losses after the buyer entered bankruptcy. AAR believes it has defenses, but stated that a loss is reasonably possible and that the potential loss cannot currently be estimated; the guarantee has no financial cap.
- A Russian bankruptcy claw-back action alleges approximately $13 million owed in connection with four engines. AAR disputes the claims and stated that a loss is reasonably possible, but the range of potential loss cannot be estimated.
- The company continues cooperating with government-agency reviews concerning potential Foreign Corrupt Practices Act and other legal violations relating to activities in Nepal and South Africa; the filing does not provide a clear estimate of potential exposure.
- AAR had $5.1 million of remaining reserves related to minimum repair-volume guarantees under a component-repair agreement, including a $1.9 million charge in Q2.
- Management identified fluctuating interest rates, foreign-exchange movements, credit losses, commercial aviation conditions, government program changes, geopolitical events, COVID-19 effects, and working-capital requirements as relevant risks.
Investor Verification Items
- Verify the sustainability of commercial aviation recovery, Aviation Services margin expansion, and the offsetting decline in government and defense activity.
- Assess inventory growth, negative operating cash flow, and the timing of working-capital conversion.
- Review leverage, interest-rate exposure, covenant headroom, and terms of the December 2022 credit agreement.
- Monitor the uncapped A220 performance guarantee and the Russian bankruptcy litigation for developments or potential estimates of loss.
- Evaluate the effect of cumulative catch-up adjustments, government-program completions, and the Expeditionary Services product mix on future profitability.
- Confirm the continuation or renewal of the accounts-receivable sale program, whose stated term ran through February 22, 2023.