AAR CORP - Annual Report: 2020 (Form 10-K)

Table of Contents

​

​

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

​

For the transition period from                 to                

Commission file number 1-6263

AAR CORP.

(Exact name of registrant as specified in its charter)

​

One AAR Place, 1100 N. Wood Dale Road, Wood Dale, Illinois 60191

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: (630) 227-2000

Securities registered pursuant to Section 12(b) of the Act:

​

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ⌧ No ◻

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ◻ No ⌧

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ⌧ No ◻

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ⌧ No ◻

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company," and "emerging growth company” in Rule 12b-2 of the Exchange Act.

​

​

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period prior to complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ◻  

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.  ⌧

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ⌧

The aggregate market value of the registrant’s voting stock held by nonaffiliates was approximately $1,474 million (based upon the closing price of the Common Stock at November 29, 2019 as reported on the New York Stock Exchange).

On June 30, 2020, there were 35,155,371 shares of Common Stock outstanding.

Documents Incorporated by Reference

Portions of the Company’s proxy statement for the Company’s 2020 Annual Meeting of Stockholders, to be held October 7, 2020, are incorporated by reference in Part III of this report.

​

​

​

​

Table of Contents

TABLE OF CONTENTS

​

​

​

​

Table of Contents

PART I

ITEM 1.BUSINESS

General

AAR CORP. and its subsidiaries are referred to herein collectively as “AAR,” “Company,” “we,” “us,” and “our” unless the context indicates otherwise.  AAR was founded in 1951, organized in 1955 and reincorporated in Delaware in 1966.  We are a diversified provider of products and services to the worldwide aviation and government and defense markets.

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 maintenance, repair and overhaul (“MRO”) activities.

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.  Our strategy to exit the capital-intensive Contractor-Owned, Contractor-Operated (“COCO”) business was also completed in fiscal 2020 as all of its assets and contracts were sold.

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.

2

Table of Contents

Business Segments

Aviation Services

The Aviation Services segment provides aftermarket support and services for the commercial aviation and government and defense markets and accounted for approximately 95% of our sales in fiscal 2020, 2019, and 2018.  In this segment, we also provide inventory management and distribution services, MRO, and engineering services.  Business activities in this segment are primarily conducted through AAR Supply Chain, Inc.; AAR Government Services, Inc.; AAR Aircraft & Engine Sales & Leasing, Inc.; AAR Aircraft Services, Inc.; AAR Allen Services, Inc.; AAR Landing Gear LLC; AAR Airlift Group, Inc.; and AAR International, Inc.

We sell and lease a wide variety of new, overhauled and repaired engine and airframe parts and components and aircraft to our commercial aviation and government/defense customers.

We provide customized flight hour component inventory and repair programs, warranty claim management, and outsourcing programs for engine and airframe parts and components in support of our airline and government customers’ maintenance activities.  The types of services provided under these programs include some or all of the following functions: material planning, sourcing, logistics, information and program management, and parts and component repair and overhaul.  We are also an authorized distributor for more than 30 product lines which include parts from over 300 Federal Supply Class codes, which we source from over 25 leading aviation original equipment manufacturers (“OEM”s).

We provide fleet management and operations of customer-owned aircraft for the U.S. Department of State (“DoS”) under the INL/A WASS contract.  We are the prime contractor on this ten-year performance-based contract which began in fiscal 2018.  Our services under the contract include operating and maintaining the global DoS fleet of fixed- and rotary-wing aircraft.

We also provide customized performance-based supply chain logistics programs in support of the U.S. Department of Defense (“DoD”) and foreign governments.  The types of services provided under these programs include some or all of the following functions: material planning, sourcing, logistics, information and program management, airframe maintenance and maintenance planning, and component repair and overhaul.

We provide major airframe inspection, maintenance, repair and overhaul, painting services, line maintenance, airframe modifications, structural repairs, avionics service and installation, exterior and interior refurbishment, and engineering services and support for many types of commercial and military aircraft.  We also repair and overhaul various components, landing gears, wheels, and brakes for commercial and military aircraft.

We operate six airframe maintenance facilities and one landing gear overhaul facility.  Our landing gear overhaul facility is in Miami, Florida, where we repair and overhaul landing gear, wheels, brakes, and actuators for different types of commercial and military aircraft.  Our U.S. airframe maintenance facilities are in Indianapolis, Indiana; Oklahoma City, Oklahoma; Miami, Florida; and Rockford, Illinois and our Canadian airframe maintenance facilities are in Trois Rivieres, Quebec and Windsor, Ontario.  In the fourth quarter of fiscal 2020, we announced our decision to close our airframe maintenance hangar in Duluth, Minnesota as the facility was only supporting a single customer and its location was not convenient for many of our customers' route networks. We recognized pretax closure costs of $4.3 million in the fourth quarter primarily related to severance costs  and asset impairment charges.  

In addition to our North American facilities, we also have an interest in a joint venture to develop and operate an airframe maintenance facility in India. The facility construction is expected to be completed in fiscal 2021.

The majority of our product sales are made pursuant to standard commercial purchase orders.  Government sales are generally made under standard types of government contracts, which can include firm fixed-price contracts, cost plus fixed fee contracts, and time-and-materials contracts.  For cost plus fixed fee contracts, we typically receive reimbursement of our costs, to the extent the costs are allowable under contractual and regulatory provisions, in addition to receiving a fixed fee.  Some of our contracts call for the performance of specified services or the delivery of specified products under indefinite delivery/indefinite quantity (“ID/IQ”) arrangements.  Certain inventory supply and management and performance-based logistics program agreements reflect negotiated terms and conditions.

3

Table of Contents

To support activities within the Aviation Services segment, we acquire aviation parts and components from domestic and foreign airlines, independent aviation service companies, aircraft leasing companies, and OEMs.  We have ongoing arrangements with OEMs that provide us access to parts, repair manuals, and service bulletins in support of parts manufactured by them.  Although the terms of each arrangement vary, they typically are made on standard OEM terms as to duration, price, and delivery.  From time to time, we purchase airframes and engines for disassembly into individual parts and components.  Airframes and engines may also be leased to airlines on a short-term basis prior to disassembly or sale.

Expeditionary Services

The Expeditionary Services segment primarily consists of businesses that provide products and services supporting the movement of equipment and personnel by the U.S. and foreign governments and non-governmental organizations.  The Expeditionary Services segment accounted for approximately 5% of our sales in fiscal 2020, 2019, and 2018.  Business activities in this segment are primarily conducted through AAR Manufacturing, Inc. and Brown International Corporation.

We design, manufacture, and repair transportation pallets and a wide variety of containers and shelters used in support of military and humanitarian tactical deployment activities.  The containers and shelters are used in numerous mission requirements, including armories, supply and parts storage, refrigeration systems, tactical operation centers, briefing rooms, laundry and kitchen facilities, water treatment, and sleeping quarters.  Shelters include both stationary and vehicle-mounted applications.We also provide engineering, design, and system integration services for specialized command and control systems.

We also design and manufacture advanced composite materials for commercial, business and military aircraft (“Composites”).  On June 23, 2020, we entered into a definitive agreement to sell our Composites business as this divestiture is consistent with our multi-year strategy to focus our portfolio on our core services offerings.  We expect the sale to close in the third quarter of calendar 2020 and will recognize a charge in the first quarter of fiscal 2021 of approximately $20 million in conjunction with the transaction.

Sales in this segment are generally made to customers pursuant to standard commercial purchase orders and contracts.  Government sales are generally made under standard types of government contracts, which can include firm fixed-price contracts, cost plus fixed fee contracts, and time-and-materials contracts.  Some of our contracts call for the performance of specified services or the delivery of specified products under ID/IQ arrangements, however, the majority of our products and services are procured via definite contracts.

Raw Materials

Although we generated approximately 55% of our fiscal 2020 sales from the sale of products, we are generally engaged in only limited manufacturing activities and have minimal exposure to fluctuations in both the availability and pricing of raw materials.  We purchase raw materials for our manufacturing operations, including steel, aluminum, extrusions, balsa, and other necessary supplies from several vendors.  Where necessary, we have been able to obtain raw materials and other inventory items from numerous sources for each segment at competitive prices, terms, and conditions, and we expect to be able to continue to do so.

Terms of Sale

We generally sell our products and services under standard 30-day payment terms.  On occasion, certain customers will negotiate extended payment terms of 60-90 days.  Except for customary warranty provisions, customers neither have the right to return products nor do they have the right to extended financing.  Our government contracts may extend several years and include one or more base years and one or more option years.  The government generally has the right not to exercise options to extend or expand our contracts and may otherwise terminate, cancel, or modify some contracts at its convenience.

Customers

The principal customers for our products and services in the Aviation Services segment are domestic and foreign passenger airlines, domestic and foreign cargo airlines, regional and commuter airlines, business and general aviation operators, OEMs, aircraft leasing companies, aftermarket aviation support companies, the DoD and its contractors, the DoS, and foreign military organizations or governments.  In the Expeditionary Services segment, our principal customers include the DoD and its contractors, foreign military organizations or governments, defense organizations, and OEMs.

4

Table of Contents

Sales of aviation products and services to our commercial airline customers are generally affected by such factors as the number, type and average age of aircraft in service, the levels of aircraft utilization (e.g., frequency of schedules, flying hours, and take-off and landing cycles), the number of airline operators, the general economy, and the level of sales of new and used aircraft. Sales to the DoD and other government agencies are subject to a number of factors, including the level of troop deployment worldwide, government funding, competitive bidding, and requirements generated by worldwide geopolitical events.

We primarily market and sell products and services through our own employees.  In certain markets outside of the United States, we rely on foreign sales representatives to assist in the sale of our products and services.

Sales to Government and Defense Customers

Sales to global government and defense customers (including sales to branches, agencies, and departments of the U.S. government) were $778.8 million (37.6% of consolidated sales), $677.9 million (33.0% of consolidated sales) and $428.9 million (24.5% of consolidated sales) in fiscal 2020, 2019 and 2018, respectively.  Sales to branches, agencies, and departments of the U.S. government and their contractors were $668.2 million (32.2% of consolidated sales), $546.2 million (26.6% of consolidated sales) and $304.3 million (17.4% of consolidated sales) in fiscal 2020, 2019, and 2018, respectively.

Sales to government and defense customers are reported in each of our reportable segments (See Note 14 of Notes to Consolidated Financial Statements).  Since such sales are subject to competitive bidding and government funding, no assurance can be given that such sales will continue at levels previously experienced.  The majority of our U.S. government sales are for products and services supporting the DoD logistics and mobility strategy and supporting DoS flight operations.  Thus, our government contracts have changed, and may continue to change, with fluctuations in defense and other governmental agency spending and requirements.  Our government contracts are also often subject to termination for convenience by the customer; in the event of such a termination, we are contractually entitled to recover all allowable costs incurred by us through the date of termination.

Government Regulation and Certificates

The Federal Aviation Administration (“FAA”) regulates the manufacture, repair, and operation of all aircraft and aircraft parts operated in the United States.  Similar rules and regulatory authorities exist in other countries.  The inspection, maintenance and repair procedures for the various types of aircraft and equipment are prescribed by these regulatory authorities and can be performed only by certified repair facilities utilizing certified technicians.  The FAA requires that various maintenance routines be performed on aircraft engines, certain engine parts, and airframes at regular intervals based on take off and landing cycles or flight time.  Our businesses, which sell defense products and services directly to the U.S. government or through its contractors, can be subject to various laws and regulations governing pricing and other factors.

We have 12 FAA certificated repair stations in the United States, Canada, and Europe.  Of the 12 certificated FAA repair stations, seven are also European Aviation Safety Agency (“EASA”) and three are also Transport Canada Civil Aviation (“TCCA”) certificated repair stations.  Such certificates, which are ongoing in duration, are required for us to perform authorized maintenance, repair, and overhaul services for our customers and are subject to revocation by the government for non-compliance with applicable regulations.  Of the 12 FAA certificated repair stations, 11 are in the Aviation Services segment and one is held by Composites included in our Expeditionary Services segment, which is expected to be sold in third quarter of calendar 2020.  The EASA and TCCA certificated repair stations are in the Aviation Services segment.  We also have a FAR Part 135 certificate to operate aircraft, although the certificate is not active.  We believe that we possess all licenses and certifications that are material to the conduct of our business.

Competition

Competition in each of our markets is based on quality, ability to provide a broad range of products and services, speed of delivery, and price.  Competitors in our Aviation Services segment include OEMs, the service divisions of large commercial airlines, and other independent suppliers of parts, repair, and overhaul services to the commercial and defense markets.  Our Expeditionary Services segment competes with a number of divisions of large corporations and other large and small companies.  Although certain of our competitors have substantially greater financial and other resources than we do, we believe that we have maintained a satisfactory competitive position through our responsiveness to customer needs, our attention to quality, and our unique combination of market expertise and technical and financial capabilities.

5

Table of Contents

Backlog

Backlog represents the amount of revenue that we expect to derive from unshipped orders or signed contracts. Backlog includes our remaining performance obligations based on the transaction price of firm orders for which work has not yet been performed as of May 31, 2020. Backlog excludes unexercised contract options and potential orders under contracts such as ID/IQ contracts.

At May 31, 2020, our firm backlog was approximately $1.0 billion and we expect that approximately 50% of this backlog will be recognized as revenue over the next 12 months, with the majority of the remaining balance recognized as revenue over the next three years.

Employees

At May 31, 2020, we employed approximately 5,400 employees worldwide, with approximately 1,200 of these employees on furlough as of that date due to our actions to mitigate the impact from COVID-19.  Approximately 200 of our employees are subject to a collective bargaining agreement.  We also retained approximately 170 contract workers as of May 31, 2020, the majority of whom are located at our airframe maintenance facilities. We retain these contract workers as they provide unique skill sets which are necessary at certain facilities as well as mitigate demand variability with our customers.

Available Information

For additional information concerning our business segments, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business Segment Information” in Note 14 of Notes to Consolidated Financial Statements under Item 8, “Financial Statements and Supplementary Data.”

Our internet address is www.aarcorp.com.  We make available free of charge through our web site our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission.  Information contained on our web site is not a part of this report.

​

6

Table of Contents

ITEM 1A.RISK FACTORS

The following is a description of the principal risks inherent in our business.

We are affected by factors that adversely impact the commercial aviation industry.

As a provider of products and services to the commercial aviation industry, we are greatly affected by overall economic conditions of that industry. The commercial aviation industry is historically cyclical and has been negatively affected in the past by geopolitical events, high fuel and oil prices, lack of capital, and weak economic conditions. As a result of these and other events, from time to time certain of our customers have filed for bankruptcy protection or ceased operation.  The impact of instability in the global financial markets may lead airlines to reduce domestic or international capacity.  In addition, certain of our airline customers have in the past been impacted by tight credit markets, which limited their ability to buy parts, services, engines, and aircraft.

A reduction in the operating fleet of aircraft both in the U.S. and abroad will result in reduced demand for parts support and maintenance activities for the type of aircraft affected. A deteriorating airline environment may also result in additional airline bankruptcies, and in such circumstances we may not be able to fully collect outstanding accounts receivable.  Reduced demand from customers caused by weak economic conditions, including tight credit conditions and customer bankruptcies, may adversely impact our financial condition or results of operations.

Our business, financial condition, results of operations, and growth rates may be adversely affected by these and other events that impact the aviation industry, including the following:

The coronavirus pandemic has had a material adverse impact on the Company’s business, operating results, financial condition, and liquidity, and the duration and extent of the pandemic could prolong or increase the adverse impact.

In December 2019, an outbreak of COVID-19 originated in Wuhan, China, and in March 2020, the World Health Organization characterized COVID-19 as a pandemic.  Many countries, including the United States, have declared states of emergency and taken steps to restrict air travel, and many companies have adopted policies prohibiting non-essential business travel by their employees.  Even in the absence of formal restrictions and prohibitions, contagious illness and fear of contagion has adversely affected travel demand and travel behavior.  Passenger airline traffic has declined significantly since March 2020, and the decrease had a material negative impact on the financial results for the fourth quarter of fiscal 2020.  We expect to continue to see reduced demand in our non-cargo commercial businesses.  Moreover, if the COVID-19 pandemic continues to result in decreased worldwide commercial activity, it could also adversely affect the demand for airline cargo services.  Reduced numbers of aircraft flying or flight hours negatively impacts the demand for our services, and any prolonged reduction could materially and adversely affect our business, operating results, financial condition, and liquidity.

7

Table of Contents

In addition, we source parts and components for our business from various suppliers around the world. Disruptions to our supply chain and business operations, or to our suppliers’ or customers’ supply chains and business operations, could have adverse effects on our ability to provide aftermarket support and services. Moreover, a prolonged epidemic or pandemic, or the threat thereof, could result in worker absences, lower productivity, voluntary closure of our offices and facilities, travel restrictions for our employees and other disruptions to our business. Any of these could have a material adverse effect on our business, financial condition or results of operations.

The Company has taken a number of actions in response to decreased demand. In addition to reducing operating expenditures for fiscal 2021 (including by implementing furloughs, eliminating certain employee and contractor positions, temporarily reducing senior employee and director compensation, consolidating facilities and eliminating non-essential spending), we have taken steps to improve our liquidity, including drawing down our Revolving Credit Facility and seeking financial assistance under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”).  Certain subsidiaries of the Company have been approved to receive $57.2 million from the U.S. Treasury Department (“Treasury”) through the Payroll Support Program under the CARES Act. In connection with the financial assistance these subsidiaries expect to receive under the Payroll Support Program, they will be required to comply with certain provisions of the CARES Act, including the requirement that funds provided pursuant to the Payroll Support Program be used exclusively for the continuation of payment of employee wages, salaries and benefits; the requirement against involuntary terminations and furloughs and reductions in employee pay rates and benefits  from the signing date of the Payroll Support Program agreement through September 30, 2020. In addition, those subsidiaries and the Company would be subject to provisions prohibiting the repurchase of common stock and the payment of common stock dividends through September 30, 2021; and limitations on the payment of certain employee compensation through March 24, 2022. These restrictions will materially affect the Company’s operations, and the Company may not be successful in managing these impacts for the duration of the restrictions. In particular, limitations on compensation may adversely impact the Company's ability to attract and retain senior management or attract other key employees during this critical time.  Although the Company has submitted what it believes to be final CARES Act documents to Treasury for counter signature, we can provide no assurance as to the final timing, terms or receipt of any funds.

In addition, we cannot predict the impact that COVID-19 will have on our customers, suppliers, vendors, and other business partners, and each of their financial conditions; however, any material effect on these parties could adversely impact us.  The impact of COVID-19 may also exacerbate other risks discussed in this “Risk Factors” section, any of which could have a material effect on us.

Our U.S. government contracts may not continue at present sales levels, which may have a material adverse effect on our financial condition and results of operations.

Our sales to branches, agencies and departments of the U.S. government and their contractors were $668.2 million (32.2% of consolidated sales) in fiscal 2020 (See Note 14 of Notes to Consolidated Financial Statements).  The majority of our U.S. government sales is for products and services supporting DoD logistics and mobility strategy and DoS flight operations and are, therefore, subject to changes in defense and other governmental agency funding and spending.  Our contracts with the U.S. government and their contractors are typically agreements to provide products and services at a fixed price and have a term of one year or less, frequently subject to extension for one or more additional periods of one year at the option of the government customer. Sales to agencies of the U.S. government and their contractors are subject to a number of factors, including the level of troop deployment worldwide, competitive bidding, U.S. government funding, requirements generated by world events, and budgetary constraints.

U.S. government programs are subject to annual congressional budget authorization and appropriation processes.  In recent years, U.S. government appropriations have been affected by larger U.S. government budgetary issues and related legislation, including the statutory limit on the amount of permissible federal debt. These issues could negatively affect the timely collection of our U.S. government invoices.

Future congressional appropriation and authorization of defense spending and the application of sequestration remain marked by significant debate and an uncertain schedule. The federal debt limit continues to be actively debated as plans for long-term national fiscal policy are discussed. The outcome of these debates could have a significant impact on defense spending broadly and programs we support in particular.

8

Table of Contents

If there are funding delays and constraints, we may be required to continue to perform for some period of time on certain of our U.S. government contracts even if the U.S. government is unable to make timely payments.  Future budget cuts, including cuts mandated by sequestration, or future procurement decisions could result in reductions, cancellations, and/or delays of existing contracts or programs which could adversely affect our results of operations and financial condition.

In light of COVID-19, and the corresponding decrease in commercial airline activity, we anticipate that the percentage of our revenue that comes from government contracts will increase and become more important to our overall business, which would heighten the adverse effects on our results of operations and financial condition of any reduction in the sales levels of our U.S. government contracts.

If we fail to comply with government procurement laws and regulations, we could lose business and be liable for various penalties or sanctions.

We must comply with laws and regulations relating to the formation, administration, and performance of government contracts. In the U.S., these laws and regulations include the Federal Acquisition Regulations, Defense Federal Acquisition Regulations, the Truth in Negotiations Act, Cost Accounting Standards, and laws, regulations, and orders restricting the use and dissemination of classified information under the U.S. export control laws and the export of certain products and technical information and safeguarding of contractor information systems.

In addition, we are subject to U.S. government inquiries and investigations, including periodic audits of costs that we determine are reimbursable under government contracts. U.S. government agencies routinely audit government contractors to review performance under contracts, cost structure and compliance with applicable laws, regulations, and standards, as well as the adequacy of and compliance with internal control systems and policies, including the contractor’s purchasing, property, estimating, compensation and management information systems. Any costs found to be misclassified or inaccurately allocated to a specific contract are not reimbursable, and to the extent already reimbursed, must be refunded. Also, any inadequacies in our systems and policies could result in payments being withheld, penalties and reduced future business.

U.S. government rules allow contracting officers to impose contractual withholdings at no less than certain minimum levels if a contracting officer determines that one or more of a contractor’s business systems have one or more significant deficiencies. If a contracting officer were to impose such a withholding on us or even one of our prime contractors, it would increase the risk that we would not be paid in full or paid timely. If future audit adjustments exceed our estimates, our profitability could be adversely affected.

If a government inquiry or investigation uncovers improper or illegal activities, we could be subject to civil or criminal penalties or administrative sanctions, including contract termination, fines, forfeiture of fees, suspension of payment and suspension or debarment from doing business with government agencies, any of which could materially adversely affect our reputation, business, financial condition and results of operations. See Note 15 of Notes to Consolidated Financial Statements for information about certain pending proceedings.

We use estimates when accounting for long-term contracts and face risks of cost overruns and losses on these contracts.

We sell certain of our products and services to our commercial, government, and defense customers under firm contracts providing for fixed unit prices, regardless of costs incurred by us.  The cost of producing products or providing services may be adversely affected by increases in the cost of labor, materials, fuel, overhead, and other unknown variants, including manufacturing and other operational inefficiencies and differences between assumptions used by us to price a contract and actual results.  Increased costs may result in cost overruns and losses on such contracts, which could adversely affect our results of operations and financial condition.

We recognize revenue on our long-term contracts primarily over time as there is continuous transfer of control to the customer over the duration of the contract as the services are delivered, which generally requires estimates of total costs at completion, fees earned on the contract, or both. This estimation process is complex and involves significant judgment related to assumptions on flight hours, component repair costs, labor hours and rates, and contract penalties and incentives.  Adjustments to estimates are often required as work progresses, experience is gained and additional information becomes known, even though the scope of the work required under the contract may not change. Any adjustment as a result of a change in estimate is recognized as events become known. Changes in the underlying assumptions, circumstances or estimates could result in adjustments that may adversely affect our future financial results.

9

Table of Contents

If our subcontractors or suppliers fail to perform their contractual obligations, our contract profitability and our ability to win new contracts may be adversely affected.

We rely on subcontractors to perform a portion of the services we agree to provide our customers, and our suppliers provide necessary inventory and component parts. A failure by one or more of our subcontractors or suppliers to satisfactorily provide on a timely basis the agreed-upon services or supplies may affect our ability to perform our contractual obligations.  Deficiencies in the performance of our subcontractors and/or suppliers could result in liquidated damages or our customer terminating our contract for default. A termination for default could expose us to liability and adversely affect our financial performance and our ability to win new contract awards.

We are subject to significant government regulation and may need to incur significant expenses to comply with new or more stringent governmental regulation.

The aviation industry is highly regulated by the FAA in the United States and equivalent regulatory agencies in other countries. Before we sell any of our products that are to be installed in an aircraft, such as engines, engine parts and components, and airframe and accessory parts and components, they must meet certain standards of airworthiness established by the FAA or the equivalent regulatory agencies in certain other countries. We operate repair stations that are licensed by the FAA and the equivalent regulatory agencies in certain other countries, and hold certificates to operate aircraft. Specific regulations vary from country to country; although regulatory requirements in other countries are generally satisfied by compliance with FAA requirements. New and more stringent governmental regulations may be adopted in the future that, if enacted, may have an adverse impact on us.

If any of our material licenses, certificates, authorizations, or approvals were revoked or suspended by the FAA or equivalent regulatory agencies in other countries, our results of operations and financial condition may be adversely affected.

Success at our airframe maintenance facilities is dependent upon continued outsourcing by the airlines.

We currently perform airframe maintenance, repair, and overhaul activities at six leased locations.  Revenues at these facilities fluctuate based on demand for maintenance which, in turn, is driven by the number of aircraft operating and the extent of outsourcing of maintenance activities by airlines.  In addition, certain airlines operate certain new fleet types and/or newer generation aircraft and we may not have contractual arrangements to service these aircraft nor technicians trained and certified to perform the required airframe maintenance, repair, and overhaul activities.  If either the number of aircraft operating or the level of outsourcing of maintenance activities declines, we may not be able to execute our operational and financial plans at our maintenance, repair, and overhaul facilities, which could adversely affect our results of operations and financial condition.

Our operations would be adversely affected by a shortage of skilled personnel or work stoppages.

Our business has historically been dependent on educated and skilled aviation mechanics because of the complex nature of many of our products and services. Furthermore, we have a collective bargaining agreement covering approximately 200 employees. Beginning in April 2020, we furloughed a significant portion of our skilled workforce as a result of the negative impact the COVID-19 pandemic has had on the demand for our services. Although we are taking measures to maintain good relationships with our workforce, including by paying the employer and employee portion of the furloughed employees’ health insurance costs, there can be no assurance that the act of furloughing our employees will not damage employee relations or cause employees to seek work elsewhere. Should the demand for skilled personnel return to pre-COVID-19 levels, and if we are unable to quickly reassemble our skilled workforce and subsequently retain a sufficient number of skilled personnel, or we experience a significant or prolonged work stoppage in such an environment, our ability to secure new work and our results of operations and financial condition could be adversely affected.

We operate in highly competitive markets, and competitive pressures may adversely affect us.

The markets for our products and services to our commercial, government, and defense customers are highly competitive, and we face competition from a number of sources, both domestic and international.  Our competitors include aircraft manufacturers, aircraft component and parts manufacturers, airline and aircraft service companies, other companies providing maintenance, repair and overhaul services, other aircraft spare parts distributors and redistributors.  Some of our competitors have substantially greater financial and other resources than we have and others may price their products and services below our selling prices.  These competitive markets also create pressure on our ability to hire and retain qualified technicians and other skilled labor needs.  We believe that our ability to compete depends on superior customer service and support, on-time delivery, sufficient inventory availability, competitive pricing, and effective quality assurance programs.

10

Table of Contents

Our government customers, including the DoD and DoS, may turn to commercial contractors, rather than traditional defense contractors, for certain work, or may utilize set asides such as small business, women-owned, or minority-owned contractors or determine to source work internally rather than use us.  We are also impacted by bid protests from unsuccessful bidders on new program awards and task orders.  Bid protests could result in significant expense for us, contract modifications, or the award decision being overturned and loss of the contract award. Even where a bid protest does not result in the loss of an award, the resolution can extend the time until the contract activity can begin, and delay earnings.  These competitive pressures, with potential impacts on both our commercial and government business, could adversely affect our results of operations and financial condition.

We are exposed to risks associated with operating internationally.

We conduct our business in a number of foreign countries, some of which are politically unstable or subject to military or civil conflicts.  Consequently, we are subject to a variety of risks that are specific to international operations, including the following:

On January 31, 2020, the UK officially exited the European Union (“EU”) and entered a transition period during which it remains bound by EU rules and trade policy. There is significant uncertainty regarding the terms and the future relationship between the UK and the EU following the transition period. Potential adverse consequences of the UK’s exit include global market uncertainty, volatility in currency exchange rates, greater restrictions on imports and exports between the UK and other countries and increased regulatory complexities.

While we have adopted and will continue to adopt measures to reduce the potential impact of losses resulting from the risks of doing business internationally, such measures may not be adequate, and the regions in which we operate might not continue to be stable enough to allow us to operate profitably or at all.

11

Table of Contents

Acquisitions expose us to risks, including the risk that we may be unable to effectively integrate acquired businesses.

We have completed acquisitions in the past few years and we have discussions with third parties regarding acquisitions on a regular basis.  Acquisitions involve risks, including difficulties in integrating the operations and personnel, the effects of amortization of any acquired intangible assets and the potential impairment of goodwill, and the potential loss of key employees of the acquired business. In addition, acquisitions often require substantial management resources and have the potential to divert our attention from our existing business.  For any businesses we may acquire in the future, we may not be able to execute our operational, financial, or integration plans for the acquired businesses, which could adversely affect our results of operations and financial condition.

Market values for our aviation products fluctuate and we may be unable to recover our costs incurred on engines, rotable components and other aircraft parts.

We make a number of assumptions when determining the recoverability of rotable components, engines, and other assets which are on lease, available for lease, or supporting our long-term programs. These assumptions include historical sales trends, current and expected usage trends, replacement values, current and expected lease rates, residual values, future demand, and future cash flows.  Reductions in demand for these assets or declining market values, as well as differences between actual results and the assumptions utilized by us when determining the recoverability of our aircraft, engines, and other assets, could result in impairment charges in future periods, which would adversely affect our results of operations and financial condition.

We may need to reduce the carrying value of our assets.

We own and distribute a significant amount of engines, aircraft parts and components, as well as own manufacturing facilities and joint venture investments.  Recurring losses in certain operations could require us to evaluate the recoverability of the carrying value of the related assets and recognize an impairment charge through earnings to reduce the carrying value.  During fiscal 2020, 2019, and 2018, we recognized impairment charges of $11.8 million, $74.1 million, and $54.2 million, respectively, related to our COCO business which is classified as a discontinued operation.  In addition, if aircraft or engines for which we offer replacement parts or supply repair and overhaul services are retired and there are fewer aircraft that require these parts or services, our revenues may decline. We recognized impairment charges of $11.0 million in fiscal 2020 related to the exit of certain product lines across our operations.

We make a number of assumptions when determining the recoverability of our assets, including historical sales trends, current and expected usage trends, replacement values, current and expected lease rates, residual values, future demand, and future cash flows.  Differences between actual results and the assumptions utilized by us when determining the recoverability of our assets could result in impairment charges in future periods, which would adversely affect our results of operations and financial condition.

We have recorded goodwill and other intangible assets related to acquisitions.  If we are unable to achieve the projected levels of operating results, it may be necessary to record an impairment charge to reduce the carrying value of goodwill and related intangible assets. During the third quarter of fiscal 2018, we recognized a goodwill impairment charge of $9.8 million related to our COCO business.  Similarly, if we were to lose a key customer or if a regulator were to terminate any of our repair certificates at our airframe maintenance or landing gear facilities, we might be required to record an impairment charge if we were unable to operate.

We are dependent upon continued availability of financing to manage our business and to execute our business strategy, and additional financing may not be available on terms acceptable to us.

Our ability to manage our business and to execute our business strategy is dependent, in part, on the continued availability of debt and equity capital. Access to the debt and equity capital markets may be limited by various factors, including the condition of overall credit markets, general economic factors, state of the aviation industry, our financial performance, and credit ratings. Debt and equity capital may not continue to be available to us on favorable terms, or at all. Our inability to obtain financing on favorable terms could adversely affect our results of operations and financial condition.

12

Table of Contents

LIBOR, the London interbank offered rate, is the basic rate of interest used in lending between banks on the London interbank market and is widely used as a reference for setting the interest rate on loans globally. Interest rates under our Revolving Credit Facility (as defined below) are based partly on LIBOR. LIBOR is currently expected to phase out by the end of 2021. It is unclear if at that time LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. The U.S. Federal Reserve has begun publishing a Secured Overnight Funding Rate which is currently intended to serve as an alternative reference rate to LIBOR.  If the method for calculation of LIBOR changes, if LIBOR is no longer available or if lenders have increased costs due to changes in LIBOR, we may suffer from potential increases in interest rates on our borrowings. Further, we may need to renegotiate our credit facilities or any other borrowings that utilize LIBOR as a factor in determining the interest rate to replace LIBOR with the new standard that is established.

Our existing debt and expected government funding includes restrictive and/or financial covenants.

Certain financing arrangements, including our Revolving Credit Facility and our accounts receivable financing program, require us to comply with various restrictive covenants and some contain financial covenants that require us to comply with specified financial ratios and tests.  Our failure to meet these covenants could result in default under these loan and debt agreements and may result in a cross-default under other debt agreements. In the event of a default and our inability to obtain a waiver of the default, all amounts outstanding under our debt agreements could be declared immediately due and payable. Our failure to comply with these covenants could adversely affect our results of operations and financial condition.

In addition, our expected receipt of funding under Payroll Support Program under the CARES Act would require us to comply with certain covenants. If we do not comply with these covenants, the government may require us to repay the support given to us.

We may not be able to pay or maintain dividends, or we may choose not to pay dividends, and the failure to pay or maintain dividends may adversely affect our share price.

On March 17, 2020, our Board of Directors declared a regular quarterly dividend of $0.075 per share, or an aggregate of $2.6 million, which was paid on April 9, 2020 to holders of record on March 30, 2020.  This dividend may not be indicative of the amount of any future quarterly dividends.  Specifically, the Payroll Support Program under the CARES Act prohibits the Company from paying stock dividends through September 30, 2021, accordingly no dividend will be paid by the Company prior to that time assuming the receipt of funding.

After the restrictions on paying the dividend under the CARES Act lapse, our ability to pay, maintain or increase cash dividends to our stockholders is subject to the discretion of our Board of Directors and will depend on many factors, including: our ability to comply with financial covenants, the economic condition of the commercial aviation industry, the level and timing of capital expenditures, principal repayments and other capital needs, maintaining our credit ratings, our results of operations, financial condition and liquidity, and legal restrictions on the payment of dividends, including government imposed restrictions.  In the future, we may choose to not pay dividends or may not be able to pay dividends, maintain our current level of dividends, or increase them over time. The failure to maintain or pay dividends may adversely affect our share price.

Our industry is susceptible to product and other liability claims, and claims not adequately covered by insurance may adversely affect our financial condition.

Our business exposes us to possible claims for property damage and bodily injury or death, which may result if an engine, engine part or component, airframe part or accessory, or any other aviation product that we have sold, manufactured, or repaired fails, or if an aircraft we operated, serviced, or in which our products are installed, has an accident.  We carry substantial liability insurance in amounts that we believe are adequate for our risk exposure and commensurate with industry norms. However, claims may arise in the future, and our insurance coverage may not be adequate to protect us in all circumstances. Additionally, we might not be able to maintain adequate insurance coverage in the future at an acceptable cost. Any liability claim not covered by adequate insurance could adversely affect our results of operations and financial condition.

13

Table of Contents

Our business could be negatively affected by cyber or other security threats or other disruptions.

Our business depends heavily on information technology and computerized systems to communicate and operate effectively. The Company's systems and technologies, or those of third parties on which we rely, could fail or become unreliable due to equipment failures, software viruses, cyber threats, ransomware attacks, terrorist acts, natural disasters, power failures or other causes.  These threats arise in some cases as a result of our role as a defense contractor.

Cyber security threats are evolving and include, but are not limited to, malicious software, attempts to gain unauthorized access to our sensitive information, business e-mail compromises, ransomware attacks, and other electronic security breaches, including at our customers, suppliers, subcontractors, and joint venture partners, that could lead to disruptions in mission critical systems, unauthorized release of confidential or otherwise protected information, and corruption of data.

The procedures and controls we utilize to monitor and mitigate these threats may not be sufficient to prevent security threats from materializing. If any of these events were to materialize, the costs related to cyber or other security threats or disruptions may not be fully insured or indemnified and could have a material adverse effect on our reputation, operating results, and financial condition.

Moreover, expenditures incurred in implementing and maintaining cyber security and other procedures and controls could adversely affect our results of operations and financial condition.

We must comply with extensive environmental requirements, and any exposure to environmental liabilities may adversely affect us.

Federal, state, and local requirements relating to the discharge and emission of substances into the environment, the disposal of hazardous wastes, the remediation and abatement of contaminants, and other activities affecting the environment have had and may continue to have an impact on our operations. Management cannot assess the possible effect of compliance with future environmental requirements or of future environmental claims for which we may not have adequate indemnification or insurance coverage. If we were required to pay the expenses related to any future environmental claims for which neither indemnification nor insurance coverage were available, these expenses could have an adverse impact on our results of operations and financial condition.

Future environmental regulatory developments in the United States and abroad concerning environmental issues, such as climate change, could adversely affect our operations and increase operating costs and, through their impact on our customers, reduce demand for our products and services. Actions may be taken in the future by the U.S. government, state governments within the United States, foreign governments, or the International Civil Aviation Organization to regulate the emission of greenhouse gases by the aviation industry. The precise nature of any such requirements and their applicability to us and our customers are difficult to predict, but the impact to us and the aviation industry would likely be adverse and could be significant, including the potential for increased fuel costs, carbon taxes or fees, or a requirement to purchase carbon credits.

We may need to make significant capital expenditures to keep pace with technological developments in our industry.

The industries in which we participate are constantly undergoing development and change, and it is likely that new products, equipment, and methods of repair and overhaul services will be introduced in the future. We may need to make significant expenditures to purchase new equipment and to train our employees to keep pace with any new technological developments. These expenditures could adversely affect our results of operations and financial condition.

​

ITEM 1B.UNRESOLVED STAFF COMMENTS

Not Applicable.

​

14

Table of Contents

ITEM 2.PROPERTIES

In the Aviation Services segment, we conduct parts supply activities from our headquarters in Wood Dale, Illinois, which we own.  In addition to warehouse space, this facility includes executive, sales and administrative offices.  Our principal maintenance, repair, overhaul, engineering and other service activities for this segment are conducted at U.S. facilities leased by us in Indianapolis, Indiana; Oklahoma City, Oklahoma; Miami, Florida; Medley, Florida; and Rockford, Illinois and at Canadian facilities leased by us in Trois Rivieres, Quebec and Windsor, Ontario.

We also lease facilities in Garden City, New York; Jacksonville, Florida; Palm Bay, Florida; Rockledge, Florida; Brussels, Belgium; London, England; and Crawley, England, and own a building near Schiphol International Airport in the Netherlands to support activities in the Aviation Services segment.

Our principal activities in the Expeditionary Services segment are conducted at facilities we lease in Huntsville, Alabama and Sacramento, California and own in Cadillac, Michigan and Clearwater, Florida.

We also operate sales offices that support all our activities and are leased in London, England; Crawley, England; Paris, France; Rio de Janeiro, Brazil; Tokyo, Japan; Shanghai, China; Singapore, Republic of Singapore; and Dubai, UAE.

We believe that our owned and leased facilities are suitable and adequate for our operational requirements.

​

ITEM 3.LEGAL PROCEEDINGS

Note 15 of the Notes to our Consolidated Financial Statements for the year ended May 31, 2020 contained in Item 8 of this Annual Report on Form 10-K includes information on legal proceedings that constitute material contingencies for financial reporting purposes that could have a material adverse effect on our consolidated financial position or liquidity if they were resolved in a manner that is adverse to us.  The information in Note 15 is incorporated by reference in this Item 3.

There are no matters which constitute material pending legal proceedings to which we are a party other than those incorporated into this item by reference from Note 15 to our Consolidated Financial Statements for the year ended May 31, 2020 contained in this Annual Report on Form 10-K.

​

ITEM 4.MINE SAFETY DISCLOSURES

Not Applicable.

​

15

Table of Contents

Supplemental Item:

EXECUTIVE OFFICERS OF THE REGISTRANT

Information concerning each of our executive officers is set forth below:

​

Mr. Holmes is Chief Executive Officer and President, having served in that capacity since June 2018.   From June 2017 to May 2018, Mr. Holmes served as President and Chief Operating Officer.  From February 2015 to June 2017, Mr. Holmes served as Chief Operating Officer – Aviation Services.  Prior to that, Mr. Holmes served as Group Vice President, Aviation Services – Inventory Management and Distribution from 2012 to 2015, General Manager and Division President of our Allen Asset Management business from 2003 to 2012, and in various other positions since joining the Company in September 2001.  Mr. Holmes has been a director of the Company since 2017.

Mr. Gillen is Vice President and Chief Financial Officer, having served in that capacity since January 2019.  Prior to joining AAR, Mr. Gillen was Vice President and Treasurer of USG Corporation since 2017.  Prior to USG, Mr. Gillen spent nine years in investment banking with Goldman Sachs, most recently as a Vice President in their Global Industrials Group.

Ms. Garascia is Vice President, General Counsel and Secretary, having served in that capacity since February 2020.  Prior to joining the Company, from September 2013 through February 2020, Ms. Garascia served in positions of increasing responsibility for USG Corporation, most recently as Deputy General Counsel.  Prior to USG, Ms. Garascia was an attorney for the Museum of Science and Industry and the law firm of Jenner & Block.

Mr. Jessup is Vice President, Chief Commercial Officer, having served in that capacity since June 2017.  Mr. Jessup previously served as Chief Commercial Officer for the Company’s Aviation Services segment since February 2015, and prior to that, he served in various capacities within the Company’s Maintenance, Repair and Overhaul business. Prior to joining the Company in 2008, Mr. Jessup was Vice President, Sales and Marketing at Avborne Heavy Maintenance, Inc. in Miami, Florida.

Mr. Pachapa is Vice President, Controller and Chief Accounting Officer, having served in that capacity since July 2016.  Mr. Pachapa previously served as Controller since October 2015 and Senior Director of Accounting and Reporting since April 2014.  Prior to joining the Company, Mr. Pachapa was with Glanbia plc from 2011 to 2014, and with Ernst & Young LLP from 1996 to 2011.

Each executive officer is elected annually by the Board of Directors.  Executive officers continue to hold office until their successors are duly elected or until their death, resignation, termination or reassignment.

​

​

16

Table of Contents

PART II

ITEM 5.       MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on the New York Stock Exchange and the Chicago Stock Exchange under the symbol “AIR.”  On June 30, 2020, there were approximately 847 holders of common stock, including participants in security position listings.

Stockholder Return Performance Graph

The following graph compares the total return on a cumulative basis of $100 invested, and reinvestment of dividends in our common stock on May 31, 2015 to the Standard and Poor’s (“S&P”) 500 Index and the Proxy Peer Group:

​

The S&P 500 Index is comprised of domestic industry leaders in four major sectors:  Industrial, Financial, Utility, and Transportation, and serves as a broad indicator of the performance of the U.S. equity market.  The Company’s Fiscal 2020 Proxy Peer Group companies are listed as follows:

​

Three companies were removed from the prior year’s peer group: KLX Inc. was acquired, and Science Applications International Corporation and Engility Holdings, Inc. combined and the resulting company was judged to no longer be a suitable comparator company.

17

Table of Contents

The Company annually revisits the composition of the peer group to ensure that the Company's performance is measured against those of comparably-sized and situated companies. The mix of the Company's commercial and government/defense markets presents a challenge in constructing a peer group, given that many government/defense contractors have substantially greater resources than the Company.

​

Dividends

The declaration and payment of cash dividends is at the discretion of our Board of Directors and will be dependent upon our future earnings, cash flows, financial condition, capital requirements and any government restrictions.  Specifically, the Payroll Support Program under the CARES Act would prohibit the Company from paying stock dividends through September 30, 2021, accordingly no dividend will be paid by the Company prior to that time assuming receipt of the funds.

​

18

Table of Contents

ITEM 6. SELECTED FINANCIAL DATA

(In millions, except per share amounts)

​

​

​

19

Table of Contents

​

Notes:

We recognized pre-tax asset impairment charges related to our Contractor-Owned, Contractor-Operated (“COCO”) business of $11.8 million, $74.1 million, and $64.0 million in fiscal 2020, 2019, and 2018, respectively.

​

​

20

Table of Contents

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.  

21

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.  Our strategy to exit the capital-intensive Contractor-Owned, Contractor-Operated (“COCO”) business was also completed in fiscal 2020 as all of its assets and contracts were sold.  

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:

​

​

22

Table of Contents

​

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.

23

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.  

24

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.  The term loan is due in full at the expiration of the Credit Agreement on November 1, 2021 unless terminated earlier pursuant to the terms of the Credit Agreement.  Interest is payable monthly on the term loan at the offered fluctuating Canadian Dollar Offer Rate plus 125 to 225 basis points based on certain financial measurements if a Bankers’ Acceptances loan, or at the offered fluctuating Prime Rate plus 25 to 125 basis points based on certain financial measurements, if a Prime Rate loan.

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.

25

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.  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.

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:

​

Notes:

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.

26

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 forecasts for each reporting unit, which incorporated specific opportunities and risks, working capital requirements, and capital expenditure needs.  We concluded it was more likely than not that the fair value of each reporting unit exceeded its carrying value at the respective measurement dates, and thus no impairment charges were recorded in those fiscal years.  

In fiscal 2020, we elected to skip the qualitative assessment due to the unprecedented impact of COVID-19 and utilized a quantitative assessment approach for all reporting units.  We estimated the fair value of each reporting unit using primarily an income approach based on discounted cash flows.  The assumptions we used to estimate the fair value of our reporting units are based on historical performance, as well as forecasts used in our current business plan and require considerable management judgment in light of the impact of COVID-19.  All three of our reporting units have been impacted by the reduced numbers of commercial aircraft flying and the overall decline in flight hours.  We have incorporated a decline in demand from commercial airline customers for our next fiscal year followed by a multiple year recovery as passenger miles and flight hours progressively increase.

We used discount rates based on our consolidated weighted average cost of capital which is adjusted for each of our reporting units based on their specific risk, size, and industry characteristics. The fair value measurements used for our goodwill impairment testing use significant unobservable inputs, which reflect our own assumptions about the inputs that market participants would use in measuring fair value. The fair value of our reporting units is also impacted by our overall market capitalization and may be impacted by volatility in our stock price and assumed control premium, among other items.

Upon completion of the annual quantitative goodwill impairment analysis as of May 31, 2020 for our reporting units, we concluded the fair value of each reporting unit exceeded its carrying values, and thus no impairment charges were recorded.

We also evaluate the sensitivity of the discounted cash flow valuations by assessing the impact of changes in certain assumptions on the estimated fair value of each reporting unit by increasing the discount rates and/or adjusting our business plan assumptions including slower recovery of sales from COVID-19 and reduced profitability.  All of our reporting units would have had fair values substantially in excess of their carrying values under all our sensitivity scenarios.

27

Table of Contents

Inventories

Inventories are valued at the lower of cost or market (estimated net realizable value).  Cost is determined by the specific identification, average cost or first-in, first-out methods.  Write-downs are made for excess and obsolete inventories and inventories that have been impaired as a result of industry conditions.  We have utilized certain assumptions when determining the market value of inventories, such as inventory quantities and aging, historical sales of inventory, current and expected future aviation usage trends, replacement values, expected future demand, and historical scrap recovery rates.  Reductions in demand for certain of our inventories or declining market values, as well as differences between actual results and the assumptions utilized by us when determining the market value of our inventories, could result in the recognition of impairment charges in future periods.

In conjunction with the decision to exit certain product lines and facilities, we recognized inventory impairment charges of $3.9 million in fiscal 2020.

Revenue Recognition

Revenue is measured based on consideration specified in a contract with a customer, and excludes any sales incentives and amounts collected on behalf of third parties. We recognize revenue when we satisfy a performance obligation by transferring control over a product or service to a customer.

Our unit of accounting for revenue recognition is a performance obligation included in our customer contracts.  A performance obligation reflects the distinct good or service that we must transfer to a customer.  At contract inception, we evaluate if the contract should be accounted for as a single performance obligation or if the contract contains multiple performance obligations.  In some cases, our contract with the customer is considered one performance obligation as it includes factors such as whether the good or service being provided is significantly integrated with other promises in the contract, whether the service provided significantly modifies or customizes another good or service or whether the good or service is highly interdependent or interrelated.  If the contract has more than one performance obligation, we determine the standalone price of each distinct good or service underlying each performance obligation and allocate the transaction price based on their relative standalone selling prices.

The transaction price of a contract, which can include both fixed and variable amounts, is allocated to each performance obligation identified.  Some contracts contain variable consideration, which could include incremental fees or penalty provisions related to performance.  Variable consideration that can be reasonably estimated based on current assumptions and historical information is included in the transaction price at the inception of the contract but limited to the amount that is probable that a significant reversal in the amount of cumulative revenue recognized will not occur.  Variable consideration that cannot be reasonably estimated is recorded when known.

Our performance obligations are satisfied over time as work progresses or at a point in time based on transfer of control of products and services to our customers.  The majority of our sales from products are recognized at a point in time upon transfer of control to the customer, which generally occurs upon shipment.  In connection with certain sales of products, we also provide logistics services, which include inventory management, replenishment, and other related services.  The price of such services is generally included in the price of the products delivered to the customer, and revenues are recognized upon delivery of the product, at which point the customer has obtained control of the product.  We do not account for these services separate from the related product sales as the services are inputs required to fulfill part orders received from customers.

For our performance obligations that are satisfied over time, we measure progress in a manner that depicts the performance of transferring control to the customer. As such, we utilize the input method of cost-to-cost to recognize revenue over time as this depicts when control of the promised goods or services are transferred to the customer.  Revenue is recognized based on the relationship of actual costs incurred to date to the estimated total cost at completion of the performance obligation.  We are required to make certain judgments and estimates, including estimated revenues and costs, as well as inflation and the overall profitability of the arrangement.  Key assumptions involved include future labor costs and efficiencies, overhead costs, and ultimate timing of product delivery.  Differences may occur between the judgments and estimates made by management and actual program results.

Changes in estimates and assumptions related to our arrangements accounted for using the cost-to-cost method are recorded using the cumulative catch-up method of accounting.  These changes are primarily adjustments to the estimated profitability for our long-term programs where we provide component inventory management and/or repair services.

28

Table of Contents

When contracts are modified, we consider whether the modification either creates new or changes the existing enforceable rights and obligations. Contract modifications that are for goods or services that are not distinct from the existing contract, due to the significant integration with the original goods or services provided, are accounted for as if they were part of that existing contract with the effect of the contract modification recognized as an adjustment to revenue on a cumulative catch-up basis. When the modifications include additional performance obligations that are distinct, they are accounted for as a new contract and performance obligation, which are recognized prospectively.

Under most of our U.S. government contracts, if the contract is terminated for convenience, we are entitled to payment for items delivered and fair compensation for work performed, the costs of settling and paying other claims, and a reasonable profit on the costs incurred or committed.

We have elected to use certain practical expedients permitted under ASC 606.  Shipping and handling fees and costs incurred associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in Cost of sales on our Consolidated Statements of Income, and are not considered a performance obligation to our customers.  Our reported sales on our Consolidated Statements of Income are net of any sales or related non-income taxes.  We also utilize the “as invoiced” practical expedient in certain cases where performance obligations are satisfied over time and the invoiced amount corresponds directly with the value we are providing to the customer.

The timing of revenue recognition, customer billings, and cash collections results in a contract asset or contract liability at the end of each reporting period.  Contract assets consist of unbilled receivables or costs incurred where revenue recognized over time using the cost-to-cost model exceeds the amounts billed to customers.  Contract liabilities include advance payments and billings in excess of revenue recognized. Certain customers make advance payments prior to the satisfaction of our performance obligations on the contract.  These amounts are recorded as contract liabilities until such performance obligations are satisfied, either over time as costs are incurred or at a point in time when deliveries are made.  Contract assets and contract liabilities are determined on a contract-by-contract basis.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts to reflect the expected uncollectibility of accounts receivable based on past collection history and specific risks identified among uncollected accounts.  In determining the required allowance, we consider factors such as general and industry-specific economic conditions, customer credit history, and our customers’ current and expected future financial performance.  The majority of our customers are recurring customers with an established payment history.  Certain customers are required to undergo an extensive credit check prior to delivery of products or services.

We perform regular evaluations of customer payment experience, current financial condition, and risk analysis.  We may require collateral in the form of security interests in assets, letters of credit, and/or obligation guarantees from financial institutions for transactions executed on other than normal trade terms.  We also maintain trade credit insurance for certain customers to provide coverage, up to a certain limit, in the event of insolvency of some customers.

In fiscal 2019, we recognized a provision for doubtful accounts of $12.4 million related to the bankruptcy of a European airline customer.  The provision consisted of 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.

In addition, we currently have past due accounts receivable owed by former commercial program customers primarily related to our exit from customer contracts in certain geographies, including Colombia, Peru, and Poland.  Our past due accounts receivable owed by these customers was $10.9 million as of May 31, 2020 which was net of allowance for doubtful accounts of $9.3 million.

Impairment of Long-Lived Assets

We are required to test for impairment of long-lived assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable from its undiscounted cash flows.  When applying accounting standards addressing impairment of long-lived assets, we have utilized certain assumptions to estimate future undiscounted cash flows, including current and future sales volumes or lease rates, expected changes to cost structures, lease terms, residual values, market conditions, and trends impacting future demand.  Differences between actual results and the assumptions utilized by us when determining undiscounted cash flows could result in future impairments of long-lived assets.  We recognized pre-tax asset impairment charges related to our COCO business of $11.8 million, $74.1 million, and $64.0 million in fiscal 2020, 2019, and 2018, respectively, related to assets included in our COCO business, which is classified as a discontinued operation.

29

Table of Contents

We maintain a significant inventory of rotable parts and equipment to service customer aircraft and components.  Portions of that inventory are used parts that are often exchanged with parts removed from aircraft or components, and are reworked to a useable condition.  We may have to recognize an impairment of our rotable parts and equipment if we discontinue using or servicing certain aircraft models or if an older aircraft model is phased-out in the industry.  In conjunction with the decision to exit certain product lines, we recognized rotable asset impairment charges of $1.9 million in fiscal 2020.

Pension Plans

The projected benefit obligation for our benefit plans exceeds our plan assets by $27.3 million as of May 31, 2020.  Our projected benefit obligation exceeds our plan assets for both our U.S. plans and for our Netherlands plan with the U.S. benefit plans underfunded by $14.6 million and the Netherlands plan underfunded by $12.7 million.

The liabilities and net periodic cost of our pension plans are determined utilizing several actuarial assumptions, the most significant of which are the discount rate and the expected long-term rate of return on plan assets.

AAR uses discount rates to measure our benefit obligation and net periodic benefit cost for our pension plans.  We used a broad population of Aa-rated corporate bonds as of May 31, 2020 to determine the discount rate assumption.  All bonds were denominated in U.S. Dollars, with a minimum outstanding of $50.0 million.  This population of bonds was narrowed from a broader universe of over 500 Moody’s Aa-rated, non-callable (or callable with make-whole provisions) bonds by eliminating the top 10^th percentile and the bottom 40^th percentile to adjust for any pricing anomalies and to represent the bonds we would most likely select if we were to actually annuitize our pension plan liabilities.  This portfolio of bonds was used to generate a yield curve and associated spot rate curve to discount the projected benefit payments for the domestic plans.  The discount rate is the single level rate that produces the same result as the spot rate curve.

We establish the long-term asset return assumption based on a review of historical compound average asset returns, both company-specific and relating to the broad market, as well as analysis of current market and economic information and future expectations.  The current asset return assumption is supported by historical market experience for both our actual and target asset allocation.  In calculating the net pension cost, the expected return on assets is applied to a calculated value on plan assets, which recognizes changes in the fair value of plan assets in a systematic manner over five years.  The difference between this expected return and the actual return on plan assets is a component of the total net unrecognized gain or loss and is subject to amortization in the future.

New Accounting Pronouncements Adopted

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (“ASC 842”), which amended the existing accounting standards for lease accounting.  ASC 842 requires lessees to recognize a right-of-use (“ROU”) asset and lease liability on the balance sheet for most lease arrangements, including those classified as operating leases.  In addition, ASC 842 requires new qualitative and quantitative disclosures about our leasing activities.  

We adopted ASC 842 on June 1, 2019 using the modified retrospective transition approach.  Under that approach, prior periods have not been restated and continue to be reported under the accounting standards in effect for those periods.  A discussion of our revised accounting policy for leases is included in Note 11 of Notes to Consolidated Financial Statements.

We have elected the package of practical expedients, which must be elected as a package and applied consistently to all leases.  This package permits us to not reassess our prior conclusions about lease identification, lease classification and initial direct costs. In addition, we have elected the practical expedients to not separate lease and non-lease components for both lessee and lessor relationships and to not apply the recognition requirements to leases with terms of less than twelve months.

Upon adoption of ASC 842 on June 1, 2019, we recognized operating lease ROU assets of $123.2 million and operating lease liabilities of $116.8 million on our Consolidated Balance Sheet.  These amounts included operating lease ROU assets of $26.6 million and operating lease liabilities of $25.3 million related to our discontinued operations.  In addition, we recognized the remaining unamortized deferred gains of $2.5 million, net of tax, associated with sale-leaseback transactions as a cumulative effect adjustment to the opening balance of retained earnings as of June 1, 2019.  

The adoption of ASC 842 did not have a material impact on the Consolidated Statements of Operations or Cash Flows.

30

Table of Contents

The impact of the adoption of ASC 842 on our Consolidated Balance Sheet was as follows:

​

In May 2014, the FASB issued ASC 606, which provides guidance for revenue recognition.  ASC 606 superseded the revenue recognition requirements in ASC 605, Revenue Recognition, and most industry-specific guidance.

We adopted ASC 606 on June 1, 2018 using the modified retrospective method.  Under that approach, prior periods were not restated and continue to be reported under the accounting standards in effect for those periods.  We elected to use the practical expedient allowing for the application of ASC 606 only to contracts that were not completed as of June 1, 2018.  We recognized the cumulative effect of initially applying ASC 606 as a decrease of $20.4 million to the opening balance of retained earnings as of June 1, 2018.

The adoption of ASC 606 impacted us in three primary areas.  First, we have certain contracts in which revenue is recognized using the percentage of completion method over the expected term of the contract.  Under ASC 606, the contract term used for revenue recognition purposes was shortened to exclude any unexercised customer option years or incorporate customer rights to terminate the contract without significant penalty as we do not have any enforceable rights or obligations prior to the exercise of the underlying option.  The impact of this change as of June 1, 2018 resulted in the elimination of certain deferred costs and the establishment of accrued liabilities reflecting our estimated obligations under the contracts.  For this change, we recognized a decrease of $22.1 million to the opening balance of retained earnings as of June 1, 2018.

Second, we have contracts under which we perform repair services on customer-owned assets whereby the customer simultaneously receives the benefits of the repair.  These contracts also transitioned to an over time revenue recognition model as of June 1, 2018 compared to our prior policy of recognizing revenue at the time of shipment.  The impact of this change as of June 1, 2018 resulted in the elimination of certain inventory and accounts receivable amounts and the establishment of a contract asset reflecting the over time revenue recognition treatment.  For this change, we recognized an increase of $1.3 million to the opening balance of retained earnings as of June 1, 2018.

Third, we have certain contracts under which we manufacture products with no alternative use as the customer owns the underlying intellectual property and we have an enforceable right to payment from the customer.  As a result, we now recognize revenue for these contracts over time as opposed to at the time of shipment, which was our policy prior to June 1, 2018.  The impact of this change as of June 1, 2018 resulted in the elimination of certain inventory amounts and the establishment of a contract asset reflecting the over time revenue recognition treatment.  For this change, we recognized an increase of $0.4 million to the opening balance of retained earnings as of June 1, 2018.

New Accounting Pronouncements Not Yet Adopted

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments.  This ASU requires a change in the measurement approach for credit losses on financial assets measured on an amortized cost basis from an incurred loss method to an expected loss method, thereby eliminating the requirement that a credit loss be considered probable to impact the valuation of a financial asset measured on an amortized cost basis. This ASU also requires the measurement of expected credit losses to be based on relevant information about past events, including historical experience, current conditions, and a reasonable and supportable forecast of the collectability of the related financial asset.  We plan to adopt this ASU on June 1, 2020 and the adoption is not expected to have a material impact on our consolidated financial statements.

​

31

Table of Contents

ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our exposure to market risk includes fluctuating interest rates under our credit agreements, changes in foreign exchange rates, and credit losses on accounts receivable.  See Note 1 of Notes to Consolidated Financial Statements for a discussion on accounts receivable exposure.

We are exposed to the risk that our earnings and cash flows could be adversely impacted by fluctuations in interest rates.  A 10 percent increase in the average interest rate affecting our financial instruments, including the average outstanding balance of our debt obligations would not have had a significant impact on our pre-tax income during fiscal 2020.

Revenues and expenses of our foreign operations are translated at average exchange rates during the year, and balance sheet accounts are translated at year-end exchange rates.  Balance sheet translation adjustments are excluded from the results of operations and are recorded in stockholders’ equity as a component of accumulated other comprehensive loss.  A hypothetical 10 percent devaluation of the U.S. dollar against foreign currencies would not have had a material impact on our financial position or continuing operations during fiscal 2020.

​

32

Table of Contents

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

​

​

Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors

AAR CORP.:

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of AAR CORP. and subsidiaries (the Company) as of May 31, 2020 and 2019, the related consolidated statements of income, comprehensive income (loss), changes in equity, and cash flows for each of the years in the three year period ended May 31, 2020, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of May 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three year period ended May 31, 2020, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of May 31, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated July 21, 2020 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

Change in Accounting Principle

As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for leases effective June 1, 2019 due to the adoption of Accounting Standards Update No. 2016-02, Leases, and its method of accounting for revenue recognition as of June 1, 2018, due to the adoption of Accounting Standards Codification Topic 606, Revenue from Contracts with Customers.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

33

Table of Contents

Assessment of the write-down of inventories

As discussed in Note 1 to the consolidated financial statements, the inventory balance as of May 31, 2020 was $623.1 million.  The Company records inventory within the Aviation Services segment at the lower of cost or net realizable value. The write-down of slow moving inventory is recorded for excess or obsolete inventory based on certain inputs and assumptions used to determine the net realizable value. These assumptions include the number of days transpiring from the date the inventory was originally received, and the historical sales of inventory to determine recovery rates. Other inputs include current and expected future aviation usage trends, replacement values, expected future demand, and historical scrap recovery rates.

We identified the assessment of the write-down of inventories for a portion of the inventory within the Aviation Services segment as a critical audit matter. The primary inputs and assumptions used in determining the write-down of slow moving inventory include the historical recovery rates, which are based on the number of days transpiring from the date the inventory was originally received, the historical sales of inventory, and the identification of specific inventories used to service customers no longer under contract. The assessment of these inputs required a higher degree of subjective auditor judgment in evaluating the future customer demand for slow moving inventory.

The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Company’s inventory process, including controls over the Company’s evaluation of the impact on the estimate of net realizable value based on 1) the number of days transpiring from the date the inventory was originally received, 2) historical sales of inventory, and 3) specific inventory used to service customers no longer under contract. We also tested relevant information technology application controls over the determination of the number of days transpiring from the date the inventory was originally received. We evaluated the write-down to determine that it was recorded using the Company’s policy based on the number of days transpiring from the date the inventory was originally received, and the recovery rates of existing inventory based on historical sales. We also assessed that the recovery rates applied to slow moving inventory were consistent with historical sales of these inventory items. We determined that the specific inventory items written down were valued at the lower of cost or net realizable value based on observable market prices.  

Evaluation of the key inputs and assumptions used in the estimation of costs at completion of the performance obligations

As discussed in Note 1 to the consolidated financial statements, the Company recognizes revenue over time upon the satisfaction of component inventory management and repair services performance obligations based on the cost-to-cost input method, which is based on the relationship of costs incurred to date to the estimated total costs at completion of the performance obligation within the Aviation Services segment. The net favorable cumulative catch-up adjustments recognized during fiscal year 2020 associated with the Company’s component inventory management and repair services totaled $3.9 million, which resulted from changes in the estimated costs at completion of the performance obligations.

We identified the evaluation of the key inputs and assumptions used in the estimation of costs at completion of the inventory management and repair services performance obligations for certain contracts within the Aviation Services segment as a critical audit matter. The key inputs and assumptions used in determining the revenue to be recognized include current and future costs to support the program, and future labor costs. The testing of the inputs and assumptions required the application of subjective auditor judgment because of the estimation associated with the inputs and assumptions.

The primary procedures we performed to address this critical audit matter included the following. We tested certain internal controls over the Company’s revenue process, including controls over 1) the assessment of the estimated future costs, 2) actual costs incurred for each performance obligation that are used by the Company in their assessment of the measure of progress, and 3) the approval of costs recorded for each performance obligation to assess the allowability per the contract. We obtained the Company’s forecast for the cost of a selection of component inventory management and repair services and assessed that the measure of progress was determined using actual costs to date plus the estimated future costs to support the satisfaction of performance obligations. We selected a sample of contracts to test fiscal year 2020 program costs. We assessed the Company’s historical estimates to determine the consistency with the Company’s historical projected costs.

​

​

​

34

Table of Contents

AAR CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

​

​

The accompanying notes to consolidated financial statements are an integral part of these statements.

​

​

​

35

Table of Contents

AAR CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

​

​

The accompanying notes to consolidated financial statements are an integral part of these statements.

​

​

​

36

Table of Contents

AAR CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

​

​

The accompanying notes to consolidated financial statements are an integral part of these statements.

​

37

Table of Contents

AAR CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

LIABILITIES AND EQUITY

​

​

The accompanying notes to consolidated financial statements are an integral part of these statements.

​

​

38

Table of Contents

AAR CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY