What changed in this filing

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Item 7. Management’s Discussion and Analysis

2023-03-07 compared with 2022-03-15 · 65 added, 86 removed, 103 unchanged (59% of the section changed)

ITEM 7 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following management’s discussion and analysis together with the financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

You should read the following management’s discussion and analysis together with the financial statements and related notes included elsewhere in this Annual Report.

This discussion contains forward-looking statements about AerSale’s business, operations and industry that involve risks and uncertainties, such as statements regarding AerSale’s plans, objectives, expectations and intentions.

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We report our activities in two business segments:

Asset Management Solutions, comprised of activities that extract value from strategic asset acquisitions either as whole assets or by disassembling for used serviceable material (“USM”);

and TechOps, comprised of MRO activities for aircraft and their components, and sales of internally developed engineered solutions products.

Asset Management Solutions, comprised of activities that extract value from strategic asset acquisitions either as whole assets or by disassembling for used serviceable material (“USM”), and TechOps, comprised of MRO activities for aircraft and their components, sales of internally developed engineered solutions and other serviceable products.

We focus on mid-life Flight Equipment and monetize them through our Asset Management Solutions segment.

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The TechOps segment also includes MRO services for landing gear, thrust reversers, hydraulic systems, and other aircraft components.

We utilize these capabilities to support our customers’ Flight Equipment, as well as to maintain and improve our owned Flight Equipment, which is subsequently sold or leased to our customers.

These processes require a high degree of expertise on each individual aircraft or component that is being serviced.

Our knowledge of these processes allows us to

assist customers to comply with applicable regulatory and OEM requirements.

We utilize these capabilities to support our customers’ Flight Equipment, as well as to maintain and improve our own Flight Equipment, which is subsequently sold or leased to our customers.

These processes require a high degree of

expertise on each individual aircraft or component that is being serviced.

Our knowledge of these processes allows us to assist customers to comply with applicable regulatory and OEM requirements.

A significant amount of skilled labor is required to support this process, which the Company has accumulated through its diversified offerings.

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In order to develop these products, we engage in research and development activities that are expensed as incurred.

Impact of COVID-19

COVID-19 has been declared a global health pandemic by the World Health Organization.

Early in March 2020, as we began to see the impacts of the pandemic on our customers, the Company took decisive actions to position itself for the short-term impacts of COVID-19, while allowing the Company the flexibility to quickly pursue the opportunities that would follow.

The Company cancelled approximately $20.0 million of feedstock opportunities under negotiation, as it evaluated the impacts of COVID-19 on asset valuations.

The Company also reexamined its structure and executed measures in 2020 to adjust the business through strategic headcount reductions and suspension of various other initiatives to reduce costs by over $20.0 million on an annualized basis.

While the duration and extent of the COVID 19 pandemic depends on future developments that cannot be accurately predicted at this time, such as the extent and effectiveness of containment actions, and future restrictions due to different strains or variants of COVID 19, it has already had an adverse effect on the global economy and the ultimate societal and economic impact of the COVID 19 pandemic remains unknown.

Continued impact of COVID-19

The COVID-19 pandemic continues to negatively affect the global economy, our business and operations, supply chains, inflation, the labor market and the aviation industry.

Commercial air travel has been significantly disrupted by the pandemic and government and business actions in response.

Although we continue to see signs of ongoing recovery, there continues to be uncertainty with respect to when commercial air traffic will fully return to and/or exceed pre-COVID-19 levels.

For additional information related to the COVID-19 pandemic, see Part I, Item 1A.

“Risk Factors” of this Annual Report.

Impact of Ukraine Conflict and Russia Sanctions

In February of 2022, Russia invaded Ukraine and is still engaged in an active conflict against the country.

As a result, governments in the European Union, the United States, the United Kingdom, Switzerland, and other countries have enacted sanctions against Russia and Russian interests.

These sanctions include controls on the export and re-export of certain goods, supplies, and technologies, supply of aircraft and aircraft components to Russian persons or for use in Russia, subject to certain wind-down periods, and the imposition of restrictions on doing business with certain state-owned Russian customers and other investments and business activities in Russia.

In order to comply with these sanctions, we ceased pursuing future business in Russia and terminated our three leases with operators doing business in Russia, successfully recovering two aircraft with one engine still unrecovered.

Due to continued uncertainty in the ability to recover this engine from Russia or to collect insurance coverage, we have fully impaired this asset.

Although the current sanctions prohibit the continuation of certain business activities, the three leases referenced were contractually scheduled to expire in 2022 and therefore will have no material impact on our business or 2022 financial condition.

While it is difficult to predict the short or long term implications of this conflict and sanctions on the global economy and the aviation industry, we intend to fully comply with all applicable sanctions and embargoes, and do not expect the current situation will have a material adverse effect on our results of operations.

Results of Operations

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Product Sales

Whole Asset Sale

Year Ended December 31,

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Product Sales

Total revenues for the year ended December 31, 2021 increased by $131.5 million or 62.9% compared to 2020, driven by an increase of $133.3 million, or 135.0%, within Asset Management Solutions partially offset by a decrease of $1.8 million, or 1.6%, within TechOps.

Whole Asset Sale

Total revenues for the year ended December 31, 2022 increased by $68.1 million or 20.0% compared to 2021, driven by an increase of $45.6 million, or 19.7%, within Asset Management Solutions and an increase of $22.5 million, or 20.8%, within TechOps.

Asset Management Solutions

Sales in the Asset Management Solutions segment increased by $45.6 million to $277.6 million, or 19.7%, for the year ended December 31, 2022 compared to 2021, due to a $14.1 million increase in revenues from Aircraft, and a $31.5 million increase in revenues from Engines.

The increase in Aircraft revenue is primarily attributable to increased activity in the B757 product line driven by Flight Equipment sales, which amounted to a total increase of $52.8 million compared to 2020, which was partly offset by lower leasing volume of $18.2 million driven by a one-time end-of-lease maintenance settlement in the amount of $10.8 million in 2020.

The increase in Engines revenue is primarily attributable to increased activity in the RB211, CF6-80, and PW4000 product lines as a result of higher Flight Equipment sales and USM sales, for a total increase of $106.1 million, which was partially offset by lower leasing activity.

The increase in Flight Equipment sales and USM sales for Aircraft and Engines is directly related to strategic asset acquisitions we carried out during 2020 and 2021, as we identified increased demand in product lines that served the cargo market as a result of the COVID-19 pandemic.

The increase in Aircraft revenue is primarily attributable to increased activity in the B747 product line driven by Flight Equipment sales, which amounted to a total increase of $18.4 million compared to 2021, which was partly offset by lower leasing volume of $7.8 million driven by the termination of certain leases as a result of the Ukraine war, as well as the sale of previously leased Flight Equipment at the end of the lease term.

The increase in Engines revenue is primarily attributable to increased activity in the CF6-80, CFM56 and PW4000 product lines as a result of higher Flight Equipment sales of $23.4 million and higher leasing activity of $5.9 million.

The increase in Flight Equipment sales is directly related to the sale of previously leased Flight Equipment and asset acquisitions of Flight Equipment we carried out during 2021 and 2022, as we identified increased demand in product lines that served the cargo market as a result of the COVID-19 pandemic.

Cost of sales in Asset Management Solutions increased by $16.9 million to $159.4 million, or 11.9%, for the year ended December 31, 2022 compared to 2021.

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Gross profit in Asset Management Solutions increased by $28.7 million to $118.2 million, or 32.0%, for the year ended December 31, 2022 compared to 2021.

The margin increase is mainly attributable to higher margins on Flight Equipment sales and USM sales of $64.7 million, as well as lower impact of inventory reserves and impairment of Flight Equipment recorded during the year ended December 31, 2021, which amounted to $6.4 million compared to $15.9 million in 2020, offset by a one-time end-of-lease maintenance settlement in the amount of $10.8 million in 2020.

The margin increase is mainly attributable to higher margins on Flight Equipment sales and USM sales of $29.8 million, as well as lower impact of inventory reserves recorded during the year ended December 31, 2022, which amounted to $1.8 million compared to $6.4 million in 2021.

Aircraft gross profit margins increased to 35.6% for the year ended December 31, 2022, from 34.5% for the year ended December 31, 2021, due to the impact of Flight Equipment’s sales which generated an average margin of 37.9%, as well as lower inventory reserves.

Engines gross profit margins increased to 46.6% for the year ended December 31, 2022, from 41.1% for the year ended December 31, 2021, mainly due to the impact of Flight Equipment’s sales which generated an average margin of 47.6%, partly offset by the impact of USM sales due to fluctuations in the product mix.

AerSale’s revenue from the TechOps segment decreased by $1.8 million to $108.4 million, or 1.6%, for the year ended December 31, 2021, compared to 2020.

The decrease was primarily driven by a reduction in aircraft storage and related maintenance activities at our heavy MRO facilities as operators return their aircraft to service, as well as a shift in resources to support our cargo conversion projects on the B757 product line.

Cost of sales in TechOps decreased by $8.2 million to $78.6 million, or 9.4%, for the year ended December 31, 2021 compared to 2020 which is consistent with the sales decrease discussed above as well as improved margins on the heavy MRO business.

Gross profit in TechOps increased $6.4 million to $29.8 million, or 27.0%, for the year ended December 31, 2021, compared to 2020.

The increase in gross profit is primarily attributable to increased contributions from maintenance and storage programs.

Gross profit margin increased to 27.5% for the year ended December 31, 2021 compared to 21.3% for the year ended December 31, 2020, and was largely attributable to an overall change in the product mix towards higher margin storage related maintenance and capacity efficiencies.

AerSale’s revenue from the TechOps segment increased by $22.5 million to $130.9 million, or 20.8%, for the year ended December 31, 2022, compared to 2021.

The increase was primarily driven by the sale of Flight Equipment, which was purchased and controlled by the TechOps segment prior to its ultimate sale, along with improved landing gear and component repair activities;

offset by lower revenues from storage and related maintenance activities in our Roswell facility as operators continue to return aircraft into active status, as well as a shift in resources at our Goodyear facility to support our cargo conversion projects on the B757 product line.

Cost of sales in TechOps increased by $19.2 million to $97.7 million, or 24.4%, for the year ended December 31, 2022 compared to 2021, driven by costs generated from the sale of Flight Equipment of $16.1 million and cost associated with revenue fluctuations noted above .

Gross profit in TechOps increased $3.3 million to $33.2 million, or 11.1%, for the year ended December 31, 2022, compared to 2021, driven by the profit generated from the sale of Flight Equipment of $7.6 million, offset by lower gross profit of $7.0 million on MRO services.

Gross profit margin decreased to 25.3% for the year ended December 31, 2022 compared to 27.5% for the year ended December 31, 2021, and was largely attributable to lower margins generated on MRO services of 22.2% for the year ended December 31, 2022 compared to 28.2% for the year ended December 31, 2021, driven by lower margin on storage related maintenance at our Roswell facility.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by $18.9 million to $96.3 million, or 24.3%, for the year ended December 31, 2022, as compared to 2021.

The increase was mostly related to stock compensation of $12.7 million related primarily to performance-based equity awards.

Based on the Company’s performance, the Company commenced its accrual of expenses related to these performance-based awards in the third quarter of 2021.

The remaining increase relates to higher costs associated with becoming a publicly traded company.

The increase was mostly related to higher payroll expenses of $10.7 million associated with market adjustments, additional headcount, and higher share-based compensation expense of $3.8 million, as well as higher cost incurred on improvements with respect to information technology and cybersecurity, professional consulting fees, and facility costs associated with new facilities.

CARES Act Proceeds

CARES Act Proceeds increased by $2.1 million to $14.8 million for the year ended December 31, 2021, as compared to 2020.

The increase was mostly related to the additional proceeds related to the Payroll Support Extension Law and American Rescue Plan Act of 2021, which was enacted into law during 2021 and exhibited similar terms and provisions to the original Cares Act of 2020.

No CARES Act Proceeds were received or recognized for the year ended December 31, 2022, as compared to $14.8 million recognized during 2021.

The amount recognized during 2021 was the result of the Payroll Support Extension Law and American Rescue Plan Act of 2021, which was enacted into law during 2021.

Unrealized loss on investments

AerLine Holdings, Inc.

("AerLine") was a consolidating VIE prior to August 31, 2018.

Refer to Note R for additional disclosures.

(“AerLine”) was a consolidating VIE prior to August 31, 2018.

Refer to Note S for additional disclosures.

On August 31, 2018, AerLine sold the customer relationships of its operating company, XTRA Airways, in consideration for a 9.99% interest in the buyer (“Buyer”), which rolled into the equity interest of a larger holding company when the Buyer was acquired.

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We account for our private warrants as a liability at their fair value, with changes in fair value recognized in our results from operations for the period.

The fair value of our private warrants was determined using the market price of the public warrants adjusted for their lack of liquidity.

For the year ended December 31, 2021, we recorded a $2.9 million loss on the change in fair value of the warrant liability, compared to a $0.4 million loss in the prior year.

The fair value of our private warrants was determined using the Black-Scholes option pricing model.

For the year ended December 31, 2022, we recorded a $0.5 million loss on the change in fair value of the warrant liability, compared to a $2.9 loss in the prior year.

Interest Expense

Interest expense, net decreased by $0.7 million to $0.9 million for the year ended December 31, 2021, as compared to 2020 and was primarily related to lower outstanding balances under the Company’s revolving credit facility.

Interest expense, net decreased by $2.1 million to $1.1 million income for the year ended December 31, 2022, as compared to 2021 and was primarily related to higher interest yields on our deposits and lack of borrowings under the Company’s revolving credit facility.

Other Income, Net

Other Income for the Year ended December 31, 2022 increased by $1.8 million to $2.3 million, as compared to 2021 primarily due to the collection of insurance proceeds in the amount $4.3 million for the full settlement of the Air Indus insurance claim, of which $1.8 million was classified as other income.

The effective tax rate for the year ended December 31, 2022 was 24.2% compared to 24.4% for the year ended December 31, 2021.

The increase in the effective tax rate was mainly a result of a favorable permanent difference related to transaction costs paid in 2020 that did not reoccur in 2021 and to an increase in the valuation allowance in 2021.

The modest decrease in the effective tax rate was mainly a result of a decrease in favorable permanent differences offset by an increase in credits.

The difference between the effective tax rate and the statutory tax rate of 21% for the year ended December 31, 2022, was primarily due to the impact of state income taxes and executive compensation, offset by the foreign derived intangible income deduction.

The difference between the effective tax rate and the statutory tax rate of 21% for the year ended December 31, 2021, was primarily due to the impact of state income taxes, a valuation allowance and permanent differences partially offset by the foreign derived intangible income deduction.

The difference between the effective tax rate and the statutory tax rate of

21% for the year ended December 31, 2020, is primarily due to the impact of state income taxes, and permanent differences related to transaction costs and meals and entertainment expenses, amongst others.

Financial Position, Liquidity and Capital Resources

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There were no borrowings during the year ended December 31, 2022.

We had no outstanding balance on the Company’s Revolving Credit Agreement as of December 31, 2021, and we had $113.9 million of availability as of the end of 2021.

We generated cash flows from operations of $79.1 million for the year ended December 31, 2021, generated cash flows from investing activities of $13.2 million, and generated cash flows from financing activities of $8.6 million for the year ended December 31, 2021.

We believe our equity base, internally generated funds, and existing availability under our debt facility are sufficient to maintain our level of operations through December 31, 2022.

We had no outstanding balance on the Amended and Restated Credit Agreement as of December 31, 2022, and we had $106.8 million of availability as of the end of 2022.

Cash used in operations was $0.1 million, cash generated from investing activities was $41.4 million, and cash used in financing activities was $24.3 million for the year ended December 31, 2022.

We believe our equity base, internally generated funds, and existing availability under our debt facility are sufficient to maintain our level of operations over the next 12 months.

Any projections of future cash needs and cash flows beyond the next 12 months are subject to substantial uncertainty, but we believe our sources of liquidity as discussed above will be sufficient to meet our long-term cash requirements.

If an event occurs that would affect our ability to meet our capital requirements, our ability to continue to grow our asset base consistent with historical trends could be impaired and our future growth limited to that which can be funded from internally generated capital.

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Cash Flows from Operating Activities

Net cash provided by operating activities was $79.1 million for the year ended December 31, 2021 compared to cash used of $12.2 million for the same period in 2020.

The increase of $91.3 million was primarily due to higher net income from the sale of Flight Equipment and the timing of collections of lease and purchase deposits, partially offset by a reduction in inventory as sales exceeded purchases for the year .

Net cash used in operating activities was $0.1 million for the year ended December 31, 2022 compared to cash provided of $79.1 million for the same period in 2021.

The decrease of $79.2 million was primarily due to the application of previously collected deposits to the sale of whole assets during the period, along with timing of cash advances to vendors.

Cash Flows from Investing Activities

Net cash provided by investing activities was $13.2 million for the year ended December 31, 2021, compared to cash used of $21.1 million in the same period for 2020.

Cash provided from investing activities during the year ended December 31, 2021 was primarily related to the sale of Flight Equipment totaling $17.1 million, compared to cash used to acquire the ACT business unit during the year ended December 31, 2020 for a total of $17.0 million.

Net cash provided by investing activities was $41.4 million for the year ended December 31, 2022, compared to cash provided of $13.2 million in the same period for 2021.

Cash provided from investing activities during the year ended December 31, 2022 was primarily related to the sale of Flight Equipment totaling $52.8 million, compared to $17.1 million during the year ended December 31, 2021.

Cash Flows from Financing Activities

Net cash provided by financing activities for the year ended December 31, 2021 was $8.6 million, compared to cash provided of $45.2 million in the same period for 2020.

The cash provided by financing activities for 2021 is driven by proceeds from the exercise of warrants.

The cash provided by financing activities in 2020 is primarily driven by proceeds from the Merger with Monocle.

Net cash used in financing activities for the year ended December 31, 2022 was $24.3 million, compared to cash provided of $8.6 million in the same period for 2021.

The cash used in financing activities for 2022 is driven by the repurchase of common stock.

The cash provided by financing activities in 2021 is primarily driven by proceeds from the exercise of warrants.

Debt Obligations and Covenant Compliance

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We did not have any off-balance sheet arrangements as of December 31, 2022.

Refer to Note Q – Commitments and Contingencies within our Consolidated Financial Statements in this Annual Report on Form 10-K for a listing of our non-cancelable contractual obligations under operating leases.

Refer to Note Q – Leases within our Consolidated Financial Statements in this Annual Report for a listing of our non-cancelable contractual obligations under operating leases.

The Company has entered into a purchase commitment with Universal Avionics, a subsidiary of Elbit Systems, valued at $33.1 million for the acquisition of technical equipment for manufacturing our AerAware product.

The commitment is expected to be satisfied by the fourth quarter of 2023.

The Company has a commitment for the purchase of cargo conversion kits to support its B757 freighter conversion program in the amount of $37.9 million.

The commitment is expected to be satisfied during 2023.

Critical Accounting Policies and Estimates

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Actual results could differ from those estimates.

Refer to Note A to the Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K, for a listing of our significant accounting policies and estimates.

Refer to Note A to the Consolidated Financial Statements in Item 8 of this Annual Report, for a listing of our significant accounting policies and estimates.

The following is a summary of critical accounting estimates and additional information on the level of uncertainty regarding relevant changes to the estimates and assumptions.

Revenue Recognition

We measure revenue based on the consideration specified in a contract with a customer, and excludes any sales commissions and taxes collected and remitted to government agencies.

We measure revenue based on the consideration specified in a contract with a customer, and exclude any sales commissions and taxes collected and remitted to government agencies.

We recognize revenue when it satisfies a performance obligation by transferring control over a product or service to a customer.

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During the year ended December 31, 2022, we adjusted the estimated return in certain product lines as a result of new material received into inventory as well as changes in demand for certain product lines.

During the year ended December 31, 2021, we recorded an inventory reserve of $6.4 million mostly related to changes in projected demand for certain material driven by changing market conditions.

We test for impairment at least annually, or when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, by assessing qualitative factors or performing a quantitative analysis in determining whether it is more likely than not that the fair value of an asset exceeds its carrying value.

A quantitative assessment involves determining the fair value of each reporting unit using market participant assumptions.

An entity should recognize an impairment charge for the amount by which the carrying amount of a reporting unit exceeds its fair value up to the amount of goodwill allocated to that reporting unit.

For purposes of reviewing impairment and the recoverability of goodwill, AerSale’s management must make various assumptions regarding estimated future cash flows and other factors in determining the fair values of the reporting unit, including market multiples, discount rates, etc.

We performed our annual impairment analysis as of October 1, 2021 by performing a qualitative assessment, and considered factors such as the economy, industry trends, and company-specific factors and performance as an initial step in assessing the fair value of the reporting units.

We concluded that the fair value of each reporting unit exceeded their carrying values, and thus no impairment charge was recorded.

Customer Relationships and Other Intangible Assets

Intangibles arising from business combinations, including customer relationships and FAA certificates are initially recorded at fair market value.

Customer relationships are amortized over ten years and favorable leases are amortized over the remaining term of the lease.

Straight-line amortization is utilized.

Where there are no legal, regulatory, contractual, or other factors that would reasonably limit the useful life of an intangible asset, that asset is classified as indefinite lived and such intangible assets are not amortized.

Other intangible assets with indefinite and definite lives are assessed for impairment annually, or more frequently when events or circumstances indicate there may be an impairment.

These assets are carried at the estimated fair value at the time of acquisition.

AerSale performed a quantitative impairment analysis as of July 1, 2021 on the indefinite lived intangible assets and concluded there were no impairments.

We review the estimated lives and methods used to amortize other intangible assets annually.

The actual amounts of amortization expense may differ materially from our estimates, depending on the results of our annual review;

however, no significant changes to our estimates have occurred during 2021.

Impairment of Long-Lived Assets

On a quarterly basis, we monitor our Flight Equipment lease portfolio for events that may indicate that a particular asset may need to be evaluated for potential impairment.

These events may include a decision to sell an asset (in whole or as USM parts), knowledge of specific damage to an asset, or supply/demand events that may affect our ability to lease an asset in the future.

On an annual basis, even absent any such triggering event, we evaluate the carrying value of the assets in its Flight Equipment lease portfolio to determine if any impairment exists.

Impairment may be identified by several factors, including, comparison of estimated sales proceeds or undiscounted forecasted cash flows over the life of the asset with the asset’s book value.

If the forecasted undiscounted cash flows are less than the book value, the asset is written down to its fair value.

When evaluating for impairment, we

group assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities.

In our Flight Equipment portfolio, this is at the individual asset level (e.g., engine or aircraft), as each asset generates its own stream of cash flows, including lease rents, maintenance reserves and repair costs.

We make assumptions which underlie the most significant and subjective estimates in determining whether any impairment exists.

Those estimates, and the underlying assumptions, are as follows:

● Fair value – We determine fair value by reference to independent appraisals, quoted market prices (e.g., an offer to purchase) and other factors such as current data from airlines, engine manufacturers, and MRO providers as well as specific market sales and repair cost data.

● Future cash flows – when evaluating the future cash flows that an asset will generate, we make assumptions regarding the lease market for specific asset models, including estimates of market lease rates and future residual values.

If the undiscounted forecasted cash flows and fair value of our long-lived assets decrease in the future, we may incur impairment charges.

Inventory, which consists of complete aircraft and engines held for sale, as well as related parts, is valued at the lower of cost or market value.

An impairment charge for excess or inactive inventory is recorded based upon an analysis that considers current inventory levels, historical sales patterns, and future sales expectations.

We did not record an impairment of our Flight Equipment during the year ended December 31, 2021.

During the year ended December 31, 2022, we recorded an inventory reserve of $1.8 million mostly related to changes in projected demand for certain materials driven by changing market conditions.

Recent Accounting Pronouncements

The most recent adopted and to be adopted accounting pronouncements are described in Note B to AerSale’s Consolidated Financial Statements included in this Annual Report on Form 10-K.

The most recent adopted and to be adopted accounting pronouncements are described in Note B to AerSale’s Consolidated Financial Statements included in this Annual Report.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis