AAR CORP. Form 10-Q Summary
Business context and reporting period
AAR CORP. reported results for the three months ended August 31, 2016, the first quarter of fiscal 2017. The company operates through Aviation Services, which includes supply chain and maintenance, repair and overhaul activities, and Expeditionary Services, which includes airlift and mobility products and services. The interim financial statements are unaudited.
Financial performance and key metrics
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Sales | $404.8 million | $386.7 million | +4.7% |
| Gross profit | $61.5 million | $53.9 million | +14.1% |
| Gross margin | 15.2% | 13.9% | +130 bps |
| Operating income | $16.7 million | $13.6 million | +22.8% |
| Income from continuing operations | $9.9 million | $7.4 million | +33.8% |
| Net income | $9.5 million | $22.9 million | -58.5% |
| Diluted EPS | $0.28 | $0.65 | Decrease |
| Cash flow from operating activities | $(1.1) million | $(63.7) million | Improved by $62.6 million |
Net income and EPS declined primarily because the prior-year quarter included a $27.7 million gain from contingent consideration related to the sale of the Telair Cargo Group. Continuing-operations diluted EPS increased to $0.29 from $0.21.
- Aviation Services sales increased 6.0% to $334.6 million, and gross profit increased 7.0% to $53.4 million.
- Expeditionary Services sales declined 1.0% to $70.2 million, while gross profit doubled to $8.1 million, aided by a $2.5 million gain on the sale of temperature-controlled container assets and improved mobility-products profitability.
- SG&A increased $4.8 million to $44.8 million, reflecting higher business-development investment and $0.7 million of severance costs.
- Effective tax rate on continuing operations was 35.7%, compared with 35.1% in the prior-year quarter.
- Cash and equivalents were $7.9 million at August 31, 2016, down from $31.2 million at May 31, 2016. Working capital was $535.0 million.
- Total debt was $151.6 million, including $117.0 million drawn under the revolving credit facility. Long-term debt, net of current maturities and debt issuance costs, was $142.8 million.
- The $500 million revolving facility had approximately $369.0 million of availability after borrowings and letters of credit, plus $9.7 million available under foreign credit lines. Management reported compliance with all debt covenants.
- Capital expenditures were $9.4 million, treasury-stock purchases were $14.8 million, and cash dividends were $2.6 million.
Material changes versus the prior comparable period
- Revenue growth was led by Aviation Services government and defense programs, including new work supporting the U.S. Navy C-40A and Afghan Air Force C-130 fleets, as well as higher KC10 program volumes.
- Aviation Services commercial revenue benefited from aftermarket parts trading and distribution, partially offset by lower MRO revenue following the transition of the Lake Charles facility to a more limited operation.
- Aviation Services commercial gross margin improved from 15.3% to 16.0%, while government and defense gross margin decreased from 17.2% to 15.9% due primarily to sales mix.
- Operating cash use improved substantially because accounts receivable and inventory consumed less cash than in the prior-year quarter. This was partly offset by a $17.3 million increase in equipment held for or available for long-term lease to support new government and European power-by-the-hour programs.
- Financing cash flow changed from $16.3 million provided in the prior-year quarter to $15.2 million used, reflecting lower net borrowings and increased share repurchases.
- The company reclassified its composite manufacturing operations into continuing operations and retained the business as a product line within Expeditionary Services. The metal machining operation was shut down and remains in discontinued operations.
Guidance, outlook, risks, contingencies, and unusual items
- Management described commercial aviation markets as healthy, supported by strong passenger traffic, high industry load factors, and low fuel costs. Government markets supporting troop movements and related activities remained weak.
- The KC10 logistics support contract was awarded to a competitor. AAR expects to provide transition services through late fiscal 2017. KC10-related unbilled receivables were $26.9 million at August 31, 2016; the filing states these costs await customer paperwork before billing.
- On September 1, 2016, the Department of State awarded AAR the GASS contract, with a potential duration of 11 years and a stated ceiling of $10 billion, including related task orders. The incumbent contractor filed a protest on September 11, 2016, with a final decision expected no later than December 21, 2016.
- Management reported $376.9 million of cash plus unused revolving-credit capacity at August 31, 2016 and stated that it expects to invest opportunistically in expanding its services.
- Key exposures include government-contract awards and protests, the KC10 transition, airline and defense-market conditions, interest-rate and foreign-exchange fluctuations, customer credit risk, working-capital requirements, and access to capital markets.
- DynCorp’s appeal remained pending in litigation alleging trade-secret misappropriation related to the GASS proposal. AAR’s motion to dismiss had been granted by the district court.
- The filing identifies no material changes to previously disclosed risk factors and no significant changes to critical accounting policies.
Important facts investors should verify
- Outcome and timing of the protest concerning the GASS contract, including the contract’s actual task-order awards, phase-in costs, and profitability.
- Collection and billing status of the $26.9 million of unbilled KC10-related receivables and the effect of the contract transition on future revenue and gross profit.
- Sustainability of Aviation Services growth and the effects of government-program mix on segment margins.
- Cash generation after lease-equipment investment, share repurchases, dividends, and debt maturities.
- Progress and financial impact of the composite-manufacturing retention and metal-machining shutdown.
- Potential liabilities or business effects from the DynCorp appeal and other government-contract contingencies.