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 government and defense customers. This filing covers the three months ended August 31, 2020, the first quarter of fiscal 2021, with comparison to the three months ended August 31, 2019. The interim financial statements are unaudited.
Financial Performance and Position
| Metric | Q1 FY2021 | Q1 FY2020 | Change |
|---|---|---|---|
| Sales | $400.8 million | $541.5 million | Down 26.0% |
| Gross profit | $48.6 million | $81.6 million | Down 40.4% |
| Gross margin | 12.1% | 15.1% | Down approximately 300 basis points |
| Operating income | $3.2 million | $22.8 million | Down 86.0% |
| Income from continuing operations | $(13.9) million | $17.1 million | Turned to a loss |
| Net income (loss) | $(14.5) million | $4.4 million | Turned to a loss |
| Basic EPS | $(0.42) | $0.12 | Declined |
| Cash flow from operating activities | $38.9 million | $(32.4) million | Improved by $71.3 million |
- Aviation Services sales fell 29.0% to $363.6 million, primarily because commercial sales declined 48.7% to $169.6 million. Government and defense sales increased 7.0% to $194.0 million.
- Expeditionary Services sales increased 25.3% to $37.2 million, driven primarily by a U.S. Air Force cargo pallet contract.
- Commercial Aviation Services gross margin decreased to 9.6% from 16.2%, while government and defense gross margin remained 14.6%. Expeditionary Services gross margin increased to 10.8% from 5.4%.
- Results included a $19.5 million loss on the sale of the Composites business, $5.8 million of asset impairment charges, $6.0 million of severance and furlough-related costs, and a $2.2 million customer contract termination charge.
- Cash flow from continuing operations benefited from a $48.5 million CARES Act payroll grant and a $18.8 million reduction in inventories, partially offset by a $25.0 million license fee payment to Unison Industries.
- Cash, cash equivalents, and restricted cash totaled $114.1 million at August 31, 2020, compared with $424.7 million at May 31, 2020. Cash and cash equivalents alone were $107.7 million.
- Working capital was $679.9 million. The revolving credit facility had $224.5 million drawn and approximately $20.6 million of letters of credit, leaving approximately $354.9 million of availability.
- Total debt was $257.0 million before debt issuance costs, including $224.5 million under the revolving facility, $23.8 million of term debt, and an $8.7 million Payroll Support Program promissory note.
- AAR was in compliance with its financing covenants at August 31, 2020. The company had approximately $1.0 billion of remaining performance obligations, with approximately 60% expected to be recognized over the next 12 months.
Material Changes Versus the Prior Comparable Period
- COVID-19 materially reduced commercial passenger air traffic and related supply-chain and MRO volumes, driving the consolidated sales decline and lower commercial margins.
- Management implemented hiring and spending controls, compensation and benefits reductions, furloughs, a reduction in force, facility closure, and exits from underperforming contracts and assets.
- The company completed the sale of its Composites business on August 31, 2020, recognizing a $19.5 million loss. The transaction generated $1.0 million of net cash proceeds and includes contingent consideration of up to $6.5 million based on future sales targets.
- Debt declined by approximately $345.0 million from May 31, 2020, primarily because the company repaid precautionary revolving-credit borrowings drawn during the prior quarter.
- The company received $57.2 million under the CARES Act Payroll Support Program, consisting of a $48.5 million grant and an $8.7 million low-interest promissory note. The program imposes restrictions on dividends, stock repurchases, compensation, and certain workforce actions for approximately two years.
- Receivables sold under the company’s receivables-financing agreement decreased to $129.0 million from $199.0 million in the prior-year quarter.
Outlook, Risks, Contingencies, and Unusual Items
Management expects long-term Aviation Services opportunities to remain favorable, particularly for value-added commercial and government offerings, but noted substantial uncertainty regarding commercial fleet structures, aircraft utilization, passenger traffic recovery, and customer demand. Results remain sensitive to commercial aircraft flying and flight hours.
- Remaining forward loss reserves for a commercial power-by-the-hour contract totaled $3.5 million at August 31, 2020.
- The Department of Justice is investigating AAR Airlift Group under the civil False Claims Act concerning several government aviation contracts. AAR is in settlement discussions, believes it has defenses, but states that a potential loss is probable and cannot reasonably estimate the maximum exposure. Potential damages could include treble damages and penalties.
- AAR self-reported possible Foreign Corrupt Practices Act and other legal violations relating to activities in Nepal and South Africa to the Department of Justice, SEC, and U.K. Serious Fraud Office. The company is cooperating but cannot predict the outcome.
- The company faces interest-rate, foreign-exchange, credit-loss, airline-industry, economic, geopolitical, and government-contract risks. Management reported no material change to previously disclosed risk factors.
- Management concluded that disclosure controls and procedures were effective as of August 31, 2020, and reported no material changes in internal control over financial reporting.
Investor Verification Priorities
- Verify the pace and durability of commercial aviation recovery and its effect on Aviation Services volumes and margins.
- Assess the sustainability of operating cash flow excluding the $48.5 million CARES Act grant and other working-capital benefits.
- Review remaining liquidity after considering debt maturities, letters of credit, receivables-financing availability, and Payroll Support Program restrictions.
- Monitor the Department of Justice False Claims Act investigation and the self-reported international compliance matters for potential financial or operational consequences.
- Evaluate the $19.5 million Composites divestiture loss, contingent consideration, and the strategic effect of exiting non-core or underperforming operations.
- Review impairment assumptions, the $3.5 million power-by-the-hour contract reserve, and the potential for additional contract or asset charges.