AAR CORP. Fiscal 2017 Form 10-K Summary
Business context and reporting period
This filing is an annual report for the fiscal year ended May 31, 2017, rather than a fiscal 2016 fourth-quarter filing. AAR provides aviation aftermarket products and services through two segments: Aviation Services and Expeditionary Services.
- Aviation Services: Supply-chain management, parts distribution, maintenance, repair and overhaul, engineering, and aircraft-component support.
- Expeditionary Services: Government and defense airlift, mobility products, shelters, pallets, containers, systems integration, and composite manufacturing.
- Aviation Services represented 84% of fiscal 2017 sales; Expeditionary Services represented 16%.
Financial performance and position
| Metric | Fiscal 2017 | Fiscal 2016 | Change |
|---|---|---|---|
| Sales | $1,767.6 million | $1,698.9 million | 4.0% increase |
| Gross profit | $276.5 million | $237.9 million | 16.2% increase |
| Gross margin | 15.6% | 14.0% | Up approximately 160 basis points |
| Operating income | $79.6 million | $64.4 million | 23.6% increase |
| Operating margin | 4.5% | 3.8% | Improved |
| Income from continuing operations | $50.2 million | $38.3 million | 31.1% increase |
| Net income attributable to AAR | $56.5 million | $47.7 million | 18.4% increase |
| Diluted EPS | $1.64 | $1.37 | Increase |
| Cash flow from continuing operations | $24.2 million | $32.6 million | Decrease |
Fiscal 2017 sales comprised $956.6 million of product sales and $811.0 million of service sales. Sales to government and defense customers were $597.6 million, or 33.8% of consolidated sales; U.S. government and contractor sales were $454.8 million, or 25.7%.
- Aviation Services: Sales increased 4.2% to $1,485.4 million and gross profit increased 7.1% to $246.2 million. Commercial sales rose 11.1%, while defense sales declined 12.1%, primarily because of the KC-10 program wind-down.
- Expeditionary Services: Sales increased 3.0% to $282.2 million and gross profit increased to $30.3 million from $8.1 million, driven primarily by improved mobility-product profitability.
- SG&A increased 13.6% to $196.7 million because of business-development investments and legal costs associated with the INL/A contract award.
- The effective tax rate on continuing operations was 32.4%, compared with 33.9% in fiscal 2016, including a $2.2 million benefit from the settlement of previously unrecognized tax positions.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $10.3 million at May 31, 2017, versus $31.2 million a year earlier. Working capital was $553.4 million.
- Total debt was $159.3 million, including $131.0 million drawn under the revolving credit facility, a $25.0 million industrial revenue bond, and $3.3 million of capital leases.
- The revolving credit facility provides $500 million of commitments, with potential expansion to $750 million. Availability at year-end was approximately $355.4 million after borrowings and letters of credit; foreign lines provided an additional $9.6 million.
- Management reported cash plus unused revolving-credit capacity of approximately $366 million and compliance with all debt covenants.
- Fiscal 2017 cash used in financing activities was $12.1 million, including $19.8 million of share repurchases and $10.2 million of dividends. The quarterly dividend remained $0.075 per share, or $0.30 for the year.
- Capital expenditures were $33.6 million, while the company invested more than $80 million in rotable assets to support commercial aviation programs. Equipment on or available for long-term lease increased to $159.6 million from $81.1 million.
Material changes versus the prior comparable period
- Growth shifted toward commercial Aviation Services, particularly flight-hour component inventory-management and repair programs. Commercial Aviation Services sales increased $111.4 million, partly offset by a $51.0 million decline in defense sales.
- The KC-10 program generated $110.6 million of sales and $3.7 million of gross profit in fiscal 2017, compared with $148.1 million of sales and $12.0 million of gross profit in fiscal 2016. Principal services ended in January 2017, with the wind-down expected to finish in mid-fiscal 2018.
- Expeditionary Services profitability improved materially, although management stated that government-market revenue and earnings remained significantly below historical peak levels.
- Operating cash flow declined despite higher earnings because of increased investment in equipment supporting new programs.
- Backlog declined to approximately $769.4 million from $978.7 million; approximately $366.3 million was expected to be fulfilled within 12 months.
- In April 2017, AAR acquired ACLAS Global Limited’s trading business for $12.0 million at closing, with $3.0 million of deferred consideration, and obtained a component-support contract covering approximately 100 aircraft.
- The company retained its composite manufacturing operations in continuing operations and shut down its metal-machining operation during the first quarter. Prior periods were recast accordingly.
Guidance, outlook, risks and unusual items
- Management expects continued strength in Aviation Services in fiscal 2018 as new commercial programs ramp up. Most new contract awards began contributing revenue and income in fiscal 2017, with further ramp-up expected in fiscal 2018.
- Management expects increased demand for Expeditionary Services’ lower-cost solutions, but demand remains below historical levels.
- The Department of State awarded AAR the INL/A Global Aviation Support Services contract, with a potential 11-year duration and potential revenue of $10 billion including task orders. The award was stayed by the U.S. Court of Federal Claims pending a protest decision expected by October 31, 2017.
- AAR did not receive task orders under a May 2017 Afghanistan rotary-wing airlift recompete and filed a protest against awards to competitors.
- DynCorp litigation and related proceedings allege misappropriation of information associated with the INL/A proposal. The company states that the allegations are without merit; the State Department’s inspector general found no evidence that AAR used DynCorp information, and the Department of Justice and inspector general took no action.
- Fiscal 2017 discontinued-operations income of $6.3 million included a $6.7 million tax benefit from an effective settlement of a previously reserved tax position.
- Principal risks include commercial aviation cyclicality, airline credit and bankruptcy risk, government funding and contract termination, fixed-price contract cost overruns, bid protests, Afghanistan and other geopolitical exposure, regulatory compliance, cyber threats, foreign exchange, asset impairments, skilled-labor shortages, and debt-covenant compliance.
- Future contractual commitments included $273.0 million of purchase obligations, $126.5 million of operating-lease payments, and an anticipated $9.5 million of fiscal 2018 pension contributions.
Most important facts for an investor to verify
- Whether the INL/A contract protest is resolved in AAR’s favor and whether task orders generate the expected revenue.
- The pace and profitability of fiscal 2018 commercial aviation program ramp-up relative to the more than $80 million investment in rotable assets.
- The effect of the KC-10 wind-down and declining government sales on Aviation Services margins and cash flow.
- Whether the lower Expeditionary Services backlog and continued weakness in government markets persist.
- Cash conversion, inventory growth, long-term lease-asset investment, and available revolving-credit capacity.
- Exposure to fixed-price contracts, government appropriations, customer concentration, and potential impairment of inventory, rotable assets, aircraft, goodwill, and other long-lived assets.
- The eventual accounting impact of the new revenue-recognition and lease-accounting standards, which had not yet been determined in the filing.