AerSale Corp (ASLE) FY 2023 MD&A

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 Consolidated Financial Statements. 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. AerSale’s future results and financial condition may differ materially from those currently anticipated by AerSale because of the factors described in the sections entitled “Risk Factors” and “Special Note Regarding Forward-looking Statements.” A discussion of the year ended December 31, 2022 compared to the year ended December 31, 2021 is included in our Annual Report on Form 10-K for the year ending December 31, 2022, filed with the SEC on March 7, 2023 under Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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The Company

We operate as a platform for serving the commercial aviation aftermarket sector. Our top executives have on average over 30 years of experience in aircraft and engine (“Flight Equipment”) management, sales and maintenance services, and are supported by an experienced management team. We have established a global purpose built and fully integrated aviation company focused on providing products and services that maximize the value of Flight Equipment in the middle to end of its operating life cycle.

We are a worldwide provider of aftermarket commercial aircraft, engines, and their parts to passenger and cargo airlines, leasing companies, original equipment manufacturers (“OEM”), government and defense contractors, and maintenance, repair and overhaul (“MRO”) service providers. We report our activities in two business segments: Asset Management Solutions, comprised of activities that extract value from strategic Flight Equipment 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. Asset Management Solutions’ activities include monetization of assets through the lease or sale of whole assets, or through disassembly activities in support of our USM-related activities. Our monetizing services have been developed to maximize returns on mid-life Flight Equipment throughout their operating life, in conjunction with realizing the highest residual value of Flight Equipment at its retirement. We accomplish this by utilizing deep market and technical knowledge related to the management of Flight Equipment sales, leasing and MRO services. To extract value from the remaining flight time on whole assets, we provide flexible short-term (generally less than five years) leasing solutions of Flight Equipment to passenger and cargo operators across the globe. Once the value from the Flight Equipment’s flight time has been extracted, Flight Equipment is considered to be at or near the end of its useful life and is analyzed for return maximization as either whole asset sales or disassembled for sale as USM parts. Revenue from this segment is segregated between Aircraft and Engine depending on the asset type that generated the revenue. Lease revenue and the related depreciation from aircraft and engines installed on those aircraft are recognized under the Aircraft category. Revenue from sales of whole aircraft and related cost of sales are allocated between the Aircraft and Engine categories based on the allocated cost basis of the asset sold.

Our TechOps segment provides internal and third-party aviation services, including internally developed engineered solutions, full heavy aircraft maintenance and modification, component MRO, as well as end-of-life disassembly services. Our MRO business also engages in longer-term projects such as aircraft modifications, cargo and tanker conversions of aircraft, and aircraft storage. 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 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.

In addition to our aircraft and USM parts offerings, we develop Engineered Solutions consisting of Supplemental Type Certificates (“STCs”) that can be installed on existing Flight Equipment to improve performance, comply with regulatory requirements, or improve safety. An example of these solutions is the AerSafe® product line, which we designed and for which we obtained Federal Aviation Administration (“FAA”) approval to sell as a solution for compliance with the FAA’s fuel tank flammability regulations. Another example of these solutions is our AerAware™ product, an industry-leading, next generation Enhanced Flight Vision System (“EFVS”) that has recently received approval by the FAA for the Boeing B737NG product line. These products are proprietary in nature and function as non-OEM solutions to regulatory requirements and other technical challenges, often at reduced delivery time and cost for operators. In order to develop these products, we engage in research and development activities that are expensed as incurred.

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Results of Operations

Sales and gross profit for AerSale’s two business segments for the years ended in December 31, 2023 and 2022 were as follows:

Year ended December 31, 2023 compared to the year ended December 31, 2022

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Total revenues for the year ended December 31, 2023 decreased by $74.0 million or 18.1% compared to 2022, driven by a decrease of $62.4 million, or 22.5%, within Asset Management Solutions and a decrease of $11.6 million, or 8.9%, within TechOps.

Asset Management Solutions

Sales in the Asset Management Solutions segment decreased by $62.4 million to $215.2 million, or 22.5%, for the year ended December 31, 2023 compared to 2022, due to a $20.6 million decrease in revenues from Aircraft, and a $41.8 million decrease in revenues from Engines. The decrease in Aircraft revenue is primarily attributable to decreased activity in the B747 and B757 product lines due to lower Flight Equipment sales in the amount of $21.1 million resulting from softer demand in the freighter market, and lower leasing revenue of $6.3 million, partly offset by higher USM sales. The decrease in Engines revenue is primarily attributable to decreased activity in the RB211 and CF6-80 product lines as a result of lower Flight Equipment sales of $40.4 million, and lower leasing revenue of $7.9 million, partially offset by higher USM sales.

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Cost of sales in Asset Management Solutions decreased by $11.9 million to $147.5 million, or 7.4%, for the year ended December 31, 2023 compared to 2022. The decrease in cost of sales was primarily driven by the sales decrease discussed above. Gross profit in Asset Management Solutions decreased by $50.6 million to $67.7 million, or 42.8%, for the year ended December 31, 2023 compared to 2022. The gross profit decrease is mainly attributable to lower revenue generated for the year ended December 31, 2023, as noted above.

Aircraft gross profit margins decreased to 28.1% for the year ended December 31, 2023, from 35.6% for the year ended December 31, 2022, due to lower margin on Flight Equipment sales resulting from lower mix of B757 freighters. Engines gross profit margins decreased to 33.4% for the year ended December 31, 2023, from 46.6% for the year ended December 31, 2022, mainly due to lower margin on Flight Equipment sales, partly offset by higher margin on USM sales.

TechOps

AerSale’s revenue from the TechOps segment decreased by $11.6 million to $119.3 million, or 8.9%, for the year ended December 31, 2023, compared to 2022. The decrease was primarily driven by the sale of Flight Equipment during 2022, which was acquired and dedicated to the TechOps segment prior to its ultimate sale, partly offset by higher revenues from component repair activities and heavy MRO services.

Cost of sales in TechOps decreased by $3.2 million to $94.6 million, or 3.3%, for the year ended December 31, 2023 compared to 2022, driven by costs generated from the sale of Flight Equipment of $16.1 million, partially offset by cost associated with revenue fluctuations noted above. Gross profit in TechOps decreased $8.4 million to $24.8 million, or 25.3%, for the year ended December 31, 2023, compared to 2022, driven by the profit generated from the sale of Flight Equipment of $7.1 million, and lower gross profit on Product sales and MRO services. Gross profit margin decreased to 20.8% for the year ended December 31, 2023 compared to 25.3% for the year ended December 31, 2022, and was largely attributable to margins generated from the sales of Flight Equipment of 32.2% for the year ended December 31, 2022, as well as lower margin on MRO services of 19.9% for the year ended December 31, 2023 compared to 22.2% for the year ended December 31, 2022.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by $6.9 million to $103.2 million, or 7.1%, for the year ended December 31, 2023, as compared to 2022. The increase was mostly related to Company-wide cost of living adjustments, additional headcount, along with higher facility costs focused on increasing MRO capacity, as well as higher legal costs incurred.

Change in fair value of warrant liability

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 Black-Scholes option pricing model. For the year ended December 31, 2023, we recorded a $2.3 million gain on the change in fair value of the warrant liability, compared to a $0.5 million loss in the prior year.

Interest Income (Expense), Net

Interest income, net for the year ended December 31, 2023 was $0.2 million, as compared to $1.1 million for the year ended December 31, 2022. The decrease in interest income, net is due to deployment of cash on feedstock acquisitions.

Other Income, Net

Other income, net for the year ended December 31, 2023 decreased by $1.6 million to $0.7 million, as compared to 2022 primarily due to the collection of insurance proceeds during 2022 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, net.

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Income Taxes

The effective tax rate for the year ended December 31, 2023 was 27.5% compared to 24.2% for the year ended December 31, 2022. The increase in the effective tax rate was mainly a result of a valuation allowance release offset and an increase in credits offset by higher nondeductible executive compensation. The difference between the effective tax rate and the statutory tax rate of 21% for the year ended December 31, 2023, was primarily due to the impact of a valuation allowance release and an increase in credits offset by executive compensation. 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, a valuation allowance and permanent differences partially offset by the foreign derived intangible income deduction.

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Financial Position, Liquidity and Capital Resources

As of December 31, 2023, we had $5.9 million of cash and cash equivalents. We finance our growth through cash flows generated from operations and borrowings secured by our assets. We had $29.0 million outstanding under the Revolving Credit Agreement as of December 31, 2023, and we had $131.0 million of availability thereunder. We used cash in operations of $174.2 million, mostly for feedstock acquisitions of $131.9 million, generated cash from investing activities of $3.1 million, and generated cash from financing activities in the amount of $29.7 million for the year ended December 31, 2023.

During the year ended December 31, 2023, we entered into a revolving term loan collateralized by our property and equipment (the “Equipment Loan”), and borrowed $8.6 million, which remained outstanding as of December 31, 2023.

We believe our equity base, internally generated funds, and existing availability under our debt facilities 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 twelve 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.

We may, from time to time, purchase our outstanding shares of common stock through cash purchases and/or exchanges for equity or debt, open-market purchases, privately negotiated transactions or otherwise. Such purchases or exchanges, if any, will be upon such terms and at such prices as we may determine, and will depend on prevailing market conditions, our liquidity requirements, legal and regulatory considerations, contractual restrictions and other factors. Purchases, if any, will be funded through our available cash from operations. The amounts involved may be material.

Cash Flows—Year ended December 31, 2023 compared to Year ended December 31, 2022

Cash Flows from Operating Activities

Net cash used in operating activities was $174.2 million for the year ended December 31, 2023 compared to cash used of $0.1 million for the same period in 2022. The increase in cash deployed of $174.1 million was primarily due to feedstock acquisitions of $131.9 million and the impact of lower results from operations.

Cash Flows from Investing Activities

Net cash provided by investing activities was $3.1 million for the year ended December 31, 2023, compared to cash provided of $41.4 million in the same period for 2022. Cash provided by investing activities during the years ended December 31, 2023 and 2022 was driven by Flight Equipment sales.

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Cash Flows from Financing Activities

Net cash provided by financing activities for the year ended December 31, 2023 was $29.7 million, compared to cash used of $24.3 million in the same period for 2022. The cash provided by financing activities during 2023 was primarily related to the proceeds from the Equipment Loan, as more fully described below, as well as borrowing under our Revolving Credit Agreement. The cash used in financing activities in 2022 was primarily driven by the repurchase of common stock.

Debt Obligations and Covenant Compliance

Wells Fargo Senior Secured Revolving Credit Facility

Effective July 25, 2023, we amended our Revolving Credit Agreement to increase our maximum commitments under the Revolving Credit Agreement to $180.0 million aggregate amount, expandable to $200.0 million, subject to conditions and the availability of lender commitments and borrowing base limitations, and to extend the maturity date to July 24, 2028, subject to certain conditions.

Prior to the amendment, our Revolving Credit Agreement was scheduled to mature on March 12, 2024, and provided commitments for a $150.0 million revolving credit facility, including a $10.0 million sub facility for letters of credit and for borrowings on same-day notice referred to as “swingline loans, which has been retained.

The maximum amount of such commitments available at any time for borrowings and letters of credit is determined according to a borrowing base calculation equal to the sum of eligible inventory and eligible accounts receivable reduced by the aggregate amount, if any, of trade payables of the loan parties, as defined in the Revolving Credit Agreement. Extensions of credit under the Revolving Credit Agreement are available for working capital and general corporate purposes.

As of December 31, 2023, there was $29.0 million outstanding under the Revolving Credit Agreement and we had $131.0 million of availability thereunder. We were in compliance with our debt covenants for the Revolving Credit Agreement as of December 31, 2023.

Synovus Equipment Loan

On June 30, 2023, the Company entered into a property and equipment revolving term loan (the “Equipment Loan”) with a total advance commitment of $10.0 million for the purpose of financing capital expenditures on property and equipment. Once the total advance commitment is reached or commencing on June 30, 2024, whichever comes first, this facility will become a term loan with a maturity date of June 30, 2027. This loan is collateralized by the property and equipment it finances and requires interest only payment until converted to a term loan, at which point, principal and interest payments will be required.

During the year ended December 31, 2023, the Company borrowed $8.6 million under this facility, which remained outstanding as of December 31, 2023.

We were in compliance with our debt covenants for the Equipment Loan as of December 31, 2023.

Off-Balance Sheet Arrangements and Contractual Obligations

We did not have any off-balance sheet arrangements as of December 31, 2023. 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.

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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 2024.

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Critical Accounting Policies and Estimates

The preparation of Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Refer to Note B 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 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. 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. For service revenue, we utilize the input method of cost-to-cost to measure progress and 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 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 are recorded using the cumulative catch-up method of accounting. The catch-up adjustment for the current year due to changes in revenue estimates did not have a material impact on our financial statements.

Inventory Cost

We record inventory at the lower of cost or market value. For purchases of whole aircraft and engines for sale or lease, cost is determined using the specific identification method whereby total cost is the cost paid, including certain asset acquisition costs that can be capitalized, to acquire such assets as a whole.

Additionally, we purchase certain whole aircraft and engines to disassemble and supply material for our engine and airframe USM inventory. For aircraft and engine parts that originate from such dismantled aircraft and engines, cost is determined using a ratio calculated based on the relationship of the cost of the dismantled aircraft or engine at the time of purchase to the total estimated sales value of the dismantled aircraft or engine at the time of purchase. At the time of sale, this ratio is applied to the sale price of each individual airframe and/or engine part to determine its allocated cost. At the time of sale, the sum of an individual part’s allocated cost and actual repair or overhaul costs incurred represent the total cost for such part. Inventory not expected to be sold within the operating cycle is classified as non-current inventory on the Consolidated Balance Sheets.

We evaluate this ratio periodically, and if necessary, update our sales estimates and make prospective adjustments to this ratio. Any amounts identified with an estimated sales value lower than the carrying value is reduced to the estimated sales value at the time of the review. Expenditures required for the repair of engine and airframe parts are capitalized as inventory and are expensed as cost of sales when associated parts are sold. During the year ended December 31, 2023, 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, 2023, there were no adjustments to the inventory reserve.

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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.