Bulletin
Investor Alert

New York Markets Close in:

July 21, 2020, 5:22 p.m. EDT

10-K: AAR CORP

new
Watchlist Relevance
LEARN MORE

Want to see how this story relates to your watchlist?

Just add items to create a watchlist now:

or Cancel Already have a watchlist? Log In

(EDGAR Online via COMTEX) -- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Dollars in millions)

Background and Forward-Looking Statements

The following discussion and analysis of our financial condition and results of operations, and quantitative and qualitative disclosures about market risk should be read in conjunction with our consolidated financial statements and the related notes included in this Form 10-K, as well as Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended May 31, 2019, which provides additional information on comparisons of fiscal 2019 and 2018.

Management's Discussion and Analysis of Financial Condition and Results of Operations contain certain statements relating to future results, which are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on the beliefs of management, as well as assumptions and estimates based on information available to us as of the dates such assumptions and estimates are made, and are subject to certain risks and uncertainties, including those factors discussed under Item 1A, "Risk Factors," that could cause actual results to differ materially from those anticipated. Should one or more of those risks or uncertainties materialize adversely, or should underlying assumptions or estimates prove incorrect, actual results may vary materially from those described. Those events and uncertainties are difficult or impossible to predict accurately and many are beyond our control. We assume no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

General Overview

We report our activities in two business segments: Aviation Services comprised of supply chain and maintenance, repair and overhaul ("MRO") activities and Expeditionary Services comprised of manufacturing activities.

The Aviation Services segment consists of aftermarket support and services offerings that provide spare parts and maintenance support for aircraft operated by our commercial and government/defense customers. Sales in the Aviation Services segment are derived from the sale and lease of a wide variety of new, overhauled and repaired engine and airframe parts and components to the commercial aviation and government and defense markets. We provide customized inventory supply chain management, performance based logistics programs, customer fleet management and operations, and aircraft component repair management services. The segment also includes repair, maintenance and overhaul of aircraft, landing gear and components. Cost of sales consists principally of the cost of product, direct labor, and overhead.

The Expeditionary Services segment consists of primarily manufacturing operations with sales derived from the design and manufacture of pallets, shelters, and containers used to support the U.S. military's requirements for a mobile and agile force including engineering, design, and system integration services for specialized command and control systems. This segment also designs and manufactures advanced composite materials for commercial, business and military aircraft. Cost of sales consists principally of the cost of material to manufacture products, direct labor and overhead.

Our chief operating decision making officer (Chief Executive Officer) evaluates performance based on the reportable segments and utilizes gross profit as a primary profitability measure. Gross profit is calculated by subtracting cost of sales from sales. The assets and certain expenses related to corporate activities are not allocated to the segments. Our reportable segments are aligned principally around differences in products and services.

Business Trends and Outlook

Fiscal 2020 began with strategic initiatives focused on growth and execution across all of our activities in the commercial and government markets. Our momentum from a successful fiscal 2019 carried into the new year as we saw continued strength in our parts supply activities, as well as in government programs. We also realized the positive impact our efforts to attract and retain talent had in our MRO activities.

Table of Contents

We succeeded in enhancing customer relationships with multiple commercial and government customers. In fiscal 2020, we were awarded a new $118 million contract from the Naval Air Systems Command in support of the U.S. Marine Corps for the procurement, modification and delivery of two C-40 aircraft. This award demonstrates the power of our integrated services model by combining the strengths of our parts supply, government programs, MRO, and engineering teams to deliver a creative solution to the U.S. Marine Corps.

We were also awarded new long-term contracts across our parts supply activities including multiple distribution agreements for new parts and our largest commercial agreement in Japan to date covering aftermarket engine components.

As we continued to successfully execute on our recent contract awards over the last few years, we achieved strong sales growth through the first nine months of fiscal 2020 and were on track for a record year. Sales had increased $166.4 million or 11.2% over the prior year period primarily due to an increase in sales of $175.5 million or 12.5% in our Aviation Services segment reflecting the growth from new contract awards and successful execution across our Aviation Services activities.

Upon entering the fourth quarter in March, we began to see the impact of the COVID-19 pandemic on the commercial aviation industry. In response to the impact from COVID-19, we implemented significant actions to reduce fixed costs and overhead which included a freeze on new hiring, reducing or eliminating all non-essential spend, reducing compensation and benefits, furloughs, a reduction in force, and closure of an airframe maintenance facility. During the fourth quarter, we also exited underperforming contracts and assets across our operations and decided to exit our joint venture investment in a Malaysian landing gear wheel and brake facility. Additionally, in June 2020, we decided to sell our composites manufacturing business which is consistent with our multi-year strategy to focus our portfolio on our core services offerings.

We have also taken actions to preserve flexibility in our liquidity. In the fourth quarter, we elected to draw down our remaining available borrowings under our Revolving Credit Facility with the majority of that additional funding remaining in our cash accounts. We elected to borrow these additional amounts as a precautionary measure in light of economic and market uncertainty presented by COVID-19.

Over the long-term, we expect to see continued strength in our Aviation Services segment given its offerings of value-added services to both commercial and government and defense customers. We believe long-term commercial aftermarket growth trends are favorable although there is uncertainty in certain fleet types as commercial operators re-evaluate their structure. Our results of operations are affected by the amount of commercial aircraft flying and flight hours. The current COVID-19 pandemic has decreased the amount of commercial aircraft flying and flight hours and has created significant economic disruption.

Results of Operations - Fiscal 2020 Compared with Fiscal 2019

Sales and gross profit for our two business segments for the two years ended May 31, 2020 and 2019 were as follows:







                                      For the Year Ended May 31,
                                    2020         2019       % Change
        Sales:
        Aviation Services
        Commercial                $ 1,268.9    $ 1,342.3       (5.5) %
        Government and defense        695.3        578.3        20.2 %
                                  $ 1,964.2    $ 1,920.6         2.3 %
        Expeditionary Services
        Commercial                $    24.3    $    31.6      (23.1) %
        Government and defense         83.5         99.6      (16.2) %
                                  $   107.8    $   131.2      (17.8) %
        


Table of Contents







                                     For the Year Ended May 31,
                                    2020        2019      % Change
        Gross Profit (Loss):
        Aviation Services
        Commercial                $   148.0    $ 195.7      (24.4) %
        Government and defense        119.3      117.9         1.2 %
                                  $   267.3    $ 313.6      (14.8) %
        Expeditionary Services
        Commercial                $   (3.6)    $   3.0     (220.0) %
        Government and defense          5.5       13.2      (58.3) %
                                  $     1.9    $  16.2      (88.3) %
        


Aviation Services Segment

Sales in the Aviation Services segment increased $43.6 million or 2.3% over the prior year. Sales to government and defense customers increased $117.0 million or 20.2% primarily attributable to new contracts awarded recently, including the $118 million contract for the procurement, modification and delivery of two C-40 aircraft we received in early fiscal 2020.

During fiscal 2020, sales in this segment to commercial customers decreased $73.4 million or 5.5% from the prior year. We experienced an increase in sales to commercial customers of 7.2% over the first nine months of the year primarily due to higher volumes in our MRO activities as our actions to attract and retain the necessary skilled labor allowed us to capture the customer demand for these services. During the fourth quarter of fiscal 2020, the impact from COVID-19 significantly decreased our commercial sales across the majority of our operations.

Changes in estimates and assumptions related to our programs accounted for using the cost-to-cost method are recorded using the cumulative catch-up method of accounting. In fiscal 2020, we recognized favorable and unfavorable cumulative catch-up adjustments of $6.1 million and $2.2 million, respectively, compared to favorable and unfavorable cumulative catch-up adjustments of $8.0 million and $2.1 million, respectively, in fiscal 2019. When considering these adjustments on a net basis, we recognized favorable cumulative catch-up adjustments of $3.9 million and $5.9 million for fiscal 2020 and 2019, respectively. These adjustments primarily relate to our long-term programs where we provide component inventory management and/or repair services.

Cost of sales in Aviation Services increased $89.9 million or 5.6% from the prior year which was largely in line with the sales increase of 2.3% discussed above. Gross profit in the Aviation Services segment decreased $46.3 million or 14.8% from the prior year. Gross profit in this segment on sales to commercial customers decreased $47.7 million or 24.4% from the prior year primarily driven by contract termination and restructuring charges of $31.3 million across certain power-by-the-hour contracts in fiscal 2020. The charges included a reduction in revenue of $17.3 million, the establishment of forward loss reserves of $5.4 million, and other related charges of $8.6 million. During fiscal 2020, we also recognized impairment charges of $6.9 million related to the exit of certain product lines across our operations and $4.3 million related to the closure of our Duluth airframe maintenance facility.

The gross profit margin on sales to commercial customers was 11.7% compared to 14.6% in the prior year with the decreased margin largely attributable to contract termination, restructuring, and impairment charges discussed above.

Gross profit on sales to government and defense customers increased $1.4 million or 1.2% over the prior year. Gross profit margin on sales to government and defense customers decreased to 17.2% from 20.4% as the gross profit margin on our recent contract awards is lower than our existing government and defense activity.

Expeditionary Services Segment

Sales in the Expeditionary Services segment decreased $23.4 million or 17.8% from the prior year primarily due to delays in contract awards for our mobility products. Gross profit in the Expeditionary Services segment decreased $14.3 million or 88.3% from the prior year and gross profit margin decreased to 1.8% from 12.3% both primarily as a result of restructuring actions and lower sales volumes. During fiscal 2020, we consolidated our mobility products operations into one core facility and exited certain product lines as part of the consolidation. We recognized charges of $2.8 million related to facility closure costs and impairment charges.

Table of Contents

Provision for Doubtful Accounts

Provision for doubtful accounts decreased $10.4 million from the prior year primarily related to fewer bankruptcy charges in fiscal 2020. In the second quarter of fiscal 2019, we recognized a provision for doubtful accounts of $12.4 million related to the bankruptcy of a European airline customer. The provision included impairment of non-current contract assets of $7.6 million, allowance for doubtful accounts of $3.3 million, and other liabilities of $1.5 million.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $5.2 million over the prior year. As a percent of sales, selling, general and administrative expenses remained relatively flat at 10.6% in fiscal 2020 compared to 10.5% in the prior year.

Interest Expense

Interest expense decreased $0.2 million in fiscal 2020 as the impact of higher average borrowings was more than offset by lower average borrowing rates on our Revolving Credit Facility.

Income Taxes

Our fiscal 2020 effective income tax rate for continuing operations was 18.4% compared to 5.5% in the prior year. In fiscal 2019, we recognized tax benefits of $5.1 million related to the reversal of certain state valuation allowances based on the recoverability of the net operating losses and other state deferred tax assets. The effective income tax rate for fiscal 2019 also includes a benefit of $4.7 million related to the recognition of previously unrecognized uncertain tax positions and a tax benefit of $1.8 million related to tax provision to federal income tax return filing differences.

Discontinued Operations

During the third quarter of fiscal 2018, we decided to pursue the sale of our COCO business previously included in our Expeditionary Services segment. Due to this strategic shift, the assets, liabilities, and results of operations of our COCO business were reported as discontinued operations for all periods presented.

Loss from discontinued operations was $20.4 million in fiscal 2020 compared to $76.6 million in the prior year. The reduced loss of $56.2 million was primarily due to lower pre-tax impairment charges of $11.8 million in fiscal 2020 as compared to $74.1 million in fiscal 2019.

Liquidity, Capital Resources and Financial Position

Our operating activities are funded and commitments met through the generation of cash from operations. In addition to operations, our current capital resources include an unsecured Revolving Credit Facility and an accounts receivable financing program. Periodically, we may also raise capital through common stock and debt financings in the public or private markets. We continually evaluate various financing arrangements, including the issuance of common stock or debt, which would allow us to improve our liquidity position and finance future growth on commercially reasonable terms. Our continuing ability to borrow from our lenders and issue debt and equity securities to the public and private markets in the future may be negatively affected by a number of factors, including the overall health of the credit markets, general economic conditions, airline industry conditions, geo-political events, and our operating performance. Our ability to generate cash from operations is influenced primarily by our operating performance and changes in working capital.

We maintain a Revolving Credit Facility with various financial institutions, as lenders, and Bank of America, N.A., as administrative agent for the lenders. On September 25, 2019, we entered into an amendment to our Revolving Credit Facility which extended the maturity of the Revolving Credit Facility to September 25, 2024, increased the revolving credit commitment by $100 million to $600 million, and modified certain other provisions. Under certain circumstances, we have the ability to request, but our lenders are not required to grant, an increase to the revolving credit commitment by an aggregate amount of up to $300 million.

Table of Contents

Borrowings under the Revolving Credit Facility bear interest at the offered Eurodollar Rate plus 87.5 to 175 basis points based on certain financial measurements if a Eurodollar Rate loan, or at the offered fluctuating Base Rate plus 0 to 75 basis points based on certain financial measurements if a Base Rate loan.

Borrowings outstanding under the Revolving Credit Facility at May 31, 2020 were $579.5 million and there were approximately $19.9 million of outstanding letters of credit, which reduced the availability of this facility to $0.6 million. There are no other terms or covenants limiting the availability of this facility. In the fourth quarter of fiscal 2020, we elected to draw down our Revolving Credit Facility as a precautionary measure in light of economic and market uncertainty presented by COVID-19. These additional borrowings from our Revolving Credit Facility are largely being maintained in Cash and cash equivalents on our Consolidated Balance Sheet which was $404.7 million at May 31, 2020.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted in the U.S. in response to the COVID-19 pandemic. Certain of our subsidiaries expect to receive $57.2 million from the U.S. Treasury Department through the Payroll Support Program under the CARES Act. These funds will be used to pay for the salaries and benefits of certain of those subsidiaries' employees. Of the $57.2 million total amount we expect to receive, approximately $48.5 million will be a direct grant and approximately $8.7 million will be in the form of a low interest 10-year senior unsecured promissory note.

As of May 31, 2020, we also had other financing arrangements that did not limit availability on our Revolving Credit Facility including outstanding letters of credit of $11.6 million and foreign lines of credit of $9.3 million.

On October 18, 2017, we entered into the Credit Agreement with the Canadian Imperial Bank of Commerce, as lender. The Credit Agreement provided a Canadian $31 million term loan with the proceeds used to fund the acquisition of two maintenance, repair, and overhaul facilities in Canada from Premier Aviation.

On February 23, 2018, we entered into a Purchase Agreement with Citibank N.A. ("Purchaser") for the sale, from time to time, of certain accounts receivable due from certain customers (the "Purchase Agreement"). Under the Purchase Agreement, the maximum amount of receivables sold is limited to $150 million and Purchaser may, but is not required to, purchase the eligible receivables we offer to sell. The term of the Purchase Agreement runs through February 22, 2021, however, the Purchase Agreement may also be terminated earlier under certain circumstances. The term of the Purchase Agreement shall be automatically extended for annual terms unless either party provides advance notice that they do not intend to extend the term.

We have no retained interests in the sold receivables, other than limited recourse obligations in certain circumstances, and only perform collection and administrative functions for the Purchaser. We account for these receivable transfers as sales under ASC 860, Transfers and Servicing, and de-recognize the sold receivables from our Consolidated Balance Sheet.

Receivables sold under the Purchase Agreement during fiscal 2020, 2019, and 2018 were $746.4 million, $744.2 million, and $239.6, respectively. Amounts remitted to the Purchaser on their behalf during fiscal 2020, 2019, and 2018 were $758.3 million, $729.7 million, and $167.9, respectively. As of May 31, 2020 and May 31, 2019, we had collected cash of $20.0 million and $19.8 million, respectively, which was not yet remitted to the Purchaser as of those dates and was classified as Restricted cash on our Consolidated Balance Sheets.

At May 31, 2020, we complied with all financial and other covenants under each of our financing arrangements.

Cash Flows - Fiscal 2020 Compared with Fiscal 2019

Cash Flows from Operating Activities

Net cash used in operating activities-continuing operations was $19.1 million in fiscal 2020 compared to cash provided of $60.5 million in fiscal 2019. The decrease of $79.6 million was primarily attributable to timing of our cash receipts and disbursements on long-term programs.

Table of Contents

Cash Flows from Investing Activities

Net cash used in investing activities-continuing operations was $24.8 million in fiscal 2020 compared to $18.5 million in fiscal 2019. The increase from the prior year was primarily related to higher expenditures for property and equipment in the current year.

Cash Flows from Financing Activities

Net cash provided by financing activities-continuing operations was $444.5 million in fiscal 2020 compared to cash used of $47.3 million in fiscal 2019.







        Contractual Obligations and Off-Balance Sheet Arrangements
        A summary of contractual cash obligations and off-balance sheet arrangements as
        of May 31, 2020 is as follows:
                                                              Payments Due by Period
                                              Due in     Due in     Due in      Due in     Due in       After
                                              Fiscal     Fiscal     Fiscal      Fiscal     Fiscal      Fiscal
                                    Total      2021       2022       2023        2024       2025        2026
        On Balance Sheet:
        Bank borrowings            $ 602.0    $     -    $  22.5    $     -    $      -    $ 579.5    $       -
        Facilities and
        equipment operating
        leases                        99.2       16.5       14.5       12.7        10.7        8.3         36.5
        Interest1                     30.1        7.2        7.0        6.8         6.8        2.3            -
        Off Balance Sheet:
        Purchase obligations2        366.2      344.8       15.8        5.4         0.1        0.1            -
        Pension contribution3          3.1        3.1          -          -           -          -            -
        


Notes:

1 Interest associated with variable rate debt was determined using the interest rate in effect on May 31, 2020.

2 Purchase obligations arise in the ordinary course of business and represent a binding commitment to acquire inventory, including raw materials, parts, and components, as well as equipment to support the operations of our business.

3 Our contribution policy for the domestic plans is to contribute annually, at a minimum, an amount which is deductible for federal income tax purposes and that is sufficient to meet actuarially computed pension benefits. For our Netherlands pension plan, our policy is to fund at least the minimum amount required by the local laws and regulations. We anticipate contributing approximately $3.1 million to our pension plans during fiscal 2021, which includes approximately $1.1 million of the Netherlands' fiscal 2020 contribution which was deferred to fiscal 2021.

We routinely issue letters of credit and performance bonds in the ordinary course of business. These instruments are typically issued in conjunction with insurance contracts or other business requirements. The total of these instruments outstanding at May 31, 2020 was $31.5 million.

Critical Accounting Policies and Significant Estimates

Our Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States. Management has made estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities to prepare the Consolidated Financial Statements. The most significant estimates made by management include those related to assumptions used in assessing goodwill impairment, adjustments to reduce the value of inventories and certain rotable assets, revenue recognition, allowance for doubtful accounts, and assumptions used in determining pension plan obligations. Accordingly, actual results could differ materially from those estimates. The following is a summary of the accounting policies considered critical by management.

Table of Contents

Goodwill

Under accounting standards for goodwill and other intangible assets, goodwill and other intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment tests. We review and evaluate our goodwill and indefinite life intangible assets for potential impairment at a minimum annually, on May 31, or more frequently if circumstances indicate that impairment is possible.

The accounting standards for goodwill allow for either a qualitative or quantitative approach for the annual impairment test. Under the qualitative approach, factors such as macroeconomic conditions, industry and market conditions and company-specific events or circumstances are assessed to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. When the quantitative approach is utilized, we compare the fair value of each reporting unit with the carrying value of the reporting unit, including goodwill. If the estimated fair value of the reporting unit is less than the carrying value of the reporting unit, we would be required to recognize an impairment loss for the excess carrying value of the reporting unit's assets.

In fiscal 2018, we performed an interim goodwill impairment test over our former Airlift reporting unit as a result of a decision to exit our COCO business. The COCO business was reclassified to discontinued operations and goodwill was allocated to the COCO business based on its relative fair value to the reporting unit. The fair value of the reporting unit was determined based on a combination of the expected net proceeds upon sale and a discounted cash flow analysis. As the fair value of the COCO business was below its carrying value, a goodwill impairment charge of $9.8 million was recorded in the third quarter of fiscal 2018.

As of May 31, 2020, we had three reporting units, which included two in our Aviation Services segment (Aviation Supply Chain and Maintenance, Repair, and Overhaul) and one comprised of our Expeditionary Services segment. In fiscal 2019 and 2018, we utilized the qualitative assessment approach for all reporting units. Under this approach, we considered the overall industry and market conditions related to the aerospace and government/defense markets as well as conditions in the global capital markets. We also considered the long-term . . .

Jul 21, 2020

COMTEX_368301641/2041/2020-07-21T17:21:50

Is there a problem with this press release? Contact the source provider Comtex at editorial@comtex.com. You can also contact MarketWatch Customer Service via our Customer Center.

(c) 1995-2020 Cybernet Data Systems, Inc. All Rights Reserved

This Story has 0 Comments
Be the first to comment

Story Conversation

Commenting FAQs »
Link to MarketWatch's Slice.