AAR CORP. Form 10-Q Summary
Business context and reporting period
AAR CORP. operates through Aviation Services, which includes aviation supply-chain and maintenance, repair and overhaul activities, and Expeditionary Services, which includes manufacturing for military customers. This filing covers the quarter and six months ended November 30, 2020, representing fiscal 2021 second-quarter and year-to-date results. The filing is unaudited.
Commercial aviation demand was materially reduced by COVID-19, while government and defense activity increased. AAR continued to reduce fixed costs, furlough or eliminate positions, close or consolidate facilities, and exit or restructure underperforming contracts and product lines.
Financial performance and key metrics
| Metric | Three months ended Nov. 30, 2020 | Prior comparable period | Six months ended Nov. 30, 2020 | Prior comparable period |
|---|---|---|---|---|
| Sales | $403.6 million | $560.9 million | $804.4 million | $1,102.4 million |
| Operating income | $21.6 million | $28.1 million | $24.8 million | $50.9 million |
| Income from continuing operations | $14.4 million | $20.1 million | $0.5 million | $37.2 million |
| Net income (loss) | $8.2 million | $14.2 million | $(6.3) million | $18.6 million |
| Diluted EPS | $0.23 | $0.40 | $(0.18) | $0.53 |
| Cash flow from operating activities | Not separately provided for the quarter | Not separately provided for the quarter | $65.5 million | $(17.9) million |
- Second-quarter sales decreased 28.0%; six-month sales decreased 27.0%.
- Aviation Services sales declined 27.6% in the quarter and 28.3% year to date. Commercial Aviation Services sales fell 48.0% and 48.3%, respectively, while government and defense sales rose 18.7% and 12.5%.
- Expeditionary Services sales declined 35.6% in the quarter and 4.8% year to date, primarily reflecting the sale of the Composites business.
- Consolidated gross profit was $69.5 million in the quarter, or approximately 17.2% of sales, versus approximately 15.3% in the prior-year quarter. Year-to-date gross profit was $118.1 million, or approximately 14.7% of sales, versus approximately 15.2% previously.
- Quarterly operating margin was approximately 5.4%, compared with 5.0% in the prior-year quarter. Year-to-date operating margin was approximately 3.1%, compared with 4.6% previously.
- Six-month operating cash flow from continuing operations was $67.4 million, compared with $(10.2) million in the prior year. Working-capital benefits, lower inventories, and CARES Act support were partly offset by a $25.0 million Unison license payment.
Liquidity, debt, and balance sheet
- At November 30, 2020, cash and cash equivalents were $110.0 million, restricted cash was $3.0 million, and working capital was $633.5 million.
- Total debt was $222.1 million, consisting primarily of $189.5 million drawn under the $600 million revolving credit facility, a $23.9 million term loan, and an $8.7 million CARES Act promissory note. Reported long-term debt, net of issuance costs, was $220.3 million versus $600.0 million at May 31, 2020.
- Revolving-facility availability was approximately $389.8 million after $20.7 million of letters of credit. AAR stated that it was in compliance with all financing covenants.
- Cash, cash equivalents, and restricted cash declined by $311.7 million during the six months to $113.0 million, primarily because the company repaid $390.0 million of short-term borrowings.
- Six-month capital expenditures were $6.0 million. AAR also received $10.0 million from terminating split-dollar life-insurance policies.
Material changes and unusual items
- 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 up to $6.5 million of contingent earn-out consideration.
- AAR received $57.2 million under the CARES Act Payroll Support Program, comprising a $48.5 million grant and an $8.7 million promissory note. The company recognized $24.9 million of grant benefits in the first six months, reducing cost of sales and selling, general and administrative expense.
- The company recorded $8.2 million of severance and furlough-related costs, $7.0 million of impairment charges, a $1.2 million inventory reserve for an exited product line, and a $4.5 million charge related to minimum repair-volume guarantees.
- AAR paid a $25.0 million license fee to extend and expand its Unison distribution agreement through December 31, 2031.
- AAR recognized a $6.0 million increase in its reserve for a Department of Justice False Claims Act investigation, bringing the balance-sheet reserve to $8.0 million. The matter is reported in discontinued operations.
- Remaining performance obligations were approximately $750 million at November 30, 2020; approximately 50% was expected to be recognized as revenue over the following 12 months.
Outlook, risks, and contingencies
Management expects long-term Aviation Services opportunities to remain favorable, but commercial recovery depends heavily on aircraft utilization and passenger traffic. Management noted that COVID-19 continued to suppress commercial flight hours, while vaccine availability was expected to support eventual recovery. No quantitative earnings or revenue guidance was provided.
- Principal risks include prolonged weakness in commercial aviation, customer contract terminations, aircraft utilization levels, working-capital requirements, credit losses, interest-rate and foreign-exchange exposure, and compliance with debt covenants.
- The company has past-due receivables from former commercial program customers of $6.9 million, net of an $8.4 million allowance.
- The Department of Justice investigation could result in additional damages, penalties, or litigation; the maximum potential loss was not reasonably estimable.
- AAR self-reported potential Foreign Corrupt Practices Act and other legal violations involving activities in Nepal and South Africa to U.S. and U.K. authorities. The filing states that the ultimate outcome cannot currently be predicted.
- CARES Act funding imposes restrictions for approximately two years on dividends, share repurchases, employee compensation, and certain workforce actions.
Facts investors should verify
- Timing and pace of commercial aviation recovery and its effect on Aviation Services revenue, margins, and receivables.
- Sustainability of reported margins after CARES Act and foreign-government subsidies expire.
- Resolution and ultimate exposure from the DOJ False Claims Act investigation and the FCPA-related self-reports.
- Availability and renewal terms of the receivables-sale program, which had a stated term through February 22, 2021.
- Compliance with leverage and interest-coverage covenants and the company’s ability to refinance the term loan due November 1, 2021.
- Conversion of the $750 million backlog into revenue and cash flow, including the timing and profitability of long-term programs.