AAR CORP. Form 10-Q Summary
Reporting period: Quarter and six months ended November 30, 2015, representing fiscal 2016 second-quarter and year-to-date results. The financial statements are unaudited.
Business Context
AAR operates through Aviation Services, which includes aviation supply-chain and maintenance, repair and overhaul activities, and Expeditionary Services, which includes airlift, mobility products, and related systems integration. The company continued its strategy of narrowing its business focus, strengthening the balance sheet, reducing overhead, and investing in its remaining aviation services businesses.
The Telair Cargo Group and Precision Systems Manufacturing businesses are presented as discontinued operations. Telair was sold in March 2015, and AAR recognized a $27.7 million gain from contingent consideration during the first quarter of fiscal 2016.
Financial Performance and Position
| Metric | Three months ended Nov. 30, 2015 | Prior year | Six months ended Nov. 30, 2015 | Prior year |
|---|---|---|---|---|
| Sales | $423.8 million | $403.3 million | $801.6 million | $798.4 million |
| Operating income | $17.3 million | $27.7 million | $32.1 million | $52.2 million |
| Income from continuing operations | $10.4 million | $13.9 million | $18.6 million | $25.7 million |
| Net income attributable to AAR | $8.0 million | $15.2 million | $30.9 million | $29.6 million |
| Diluted EPS | $0.23 | $0.38 | $0.89 | $0.75 |
Margins: Consolidated gross profit was $59.9 million for the quarter and $114.4 million year to date, implying gross margins of approximately 14.1% and 14.3%, respectively. Operating margins were approximately 4.1% and 4.0%. The quarterly net margin was approximately 1.9%, compared with 3.8% in the prior year.
- Aviation Services: Quarterly sales increased 10.3% to $359.6 million and gross profit increased 8.0% to $58.2 million. Six-month sales increased 5.9% to $675.4 million and gross profit increased 5.9% to $108.1 million.
- Expeditionary Services: Quarterly sales declined 17.1% to $64.2 million and gross profit declined 87.2% to $1.7 million. Six-month sales declined 21.6% to $126.2 million and gross profit declined 77.1% to $6.3 million.
- Cash flow: Operating activities used $15.9 million of cash in the first six months, compared with $31.0 million provided in the prior year. Continuing operations used $17.7 million, primarily reflecting increases in accounts receivable and inventory.
- Investing and financing: Investing activities provided $23.2 million, including $19.2 million from a sale-leaseback and $27.1 million from discontinued operations. Financing activities provided $0.9 million, including $55.0 million of net short-term borrowings, $39.9 million of long-term debt repayments, $10.1 million of treasury-stock purchases, and $5.2 million of dividends.
- Liquidity: Cash was $62.8 million at November 30, 2015, compared with $54.7 million at May 31, 2015. Working capital was $632.8 million. The $500 million revolving credit facility had $105.0 million drawn and approximately $12.6 million of letters of credit, leaving approximately $382.4 million available. A further $2.7 million was available under a foreign credit line.
- Debt: Total debt was $170.3 million, compared with $154.0 million at May 31, 2015. Current maturities were $35.3 million and long-term debt was $135.0 million. The company stated that it was in compliance with all debt covenants.
Material Changes Versus the Prior Comparable Period
- Revenue growth was concentrated in Aviation Services, particularly government and defense distribution and a defense-related supply program. Aviation Services defense sales rose 33.5% in the quarter and 26.4% year to date.
- Expeditionary Services deteriorated materially because of lower Department of Defense mobility-product purchases and fewer aircraft positions in Afghanistan following the troop drawdown. Its quarterly gross margin fell to 2.6% from 17.2%; the six-month margin fell to 5.0% from 17.1%.
- Operating income declined $10.4 million for the quarter and $20.1 million year to date, primarily because of lower Expeditionary Services gross profit, higher SG&A, and lower joint-venture earnings.
- Interest expense declined $5.1 million for the quarter and $9.5 million year to date, primarily following the fiscal 2015 redemption of $325 million of 7.25% senior notes.
- Year-to-date net income benefited from the $27.7 million gain related to Telair contingent consideration. Excluding that discontinued-operations item, reported earnings were weaker than the prior year.
- Accounts receivable increased to $252.6 million from $229.0 million at May 31, 2015, and inventory increased to $462.1 million from $456.0 million. Unbilled defense-related receivables were $29.7 million.
- The company repurchased $10.1 million of treasury stock during the first six months and repurchased 141,720 shares during the quarter, with approximately $91.4 million remaining under the repurchase authorization.
Outlook, Risks, Contingencies, and Unusual Items
- Management expected weakness in Expeditionary Services to continue in the third quarter, with some improvement anticipated in the fourth quarter when an airlift search-and-rescue contract was expected to come online. No quantitative earnings or revenue guidance was provided.
- Management plans to use its strengthened balance sheet to grow the remaining businesses during fiscal 2016, while continuing to streamline operations and pursue the expected sale of PSM.
- Key risks include defense spending and troop levels, government contract awards, commercial aviation demand, working-capital requirements, credit-market access, interest rates, foreign exchange, customer credit losses, and execution of the business transformation.
- DynCorp sued AAR Airlift alleging trade-secret misappropriation related to proposals for the Department of State’s Worldwide Aviation Support Services program. DynCorp’s preliminary-injunction request was denied; AAR filed a motion to dismiss, and discovery was stayed pending a ruling. The company disclosed that damages sought were unspecified and that it would defend the matter vigorously.
- The State Department’s Office of Inspector General was investigating substantially similar allegations, and AAR Airlift was cooperating.
- The company identified no material changes to the risk factors in its fiscal 2015 Form 10-K. Disclosure controls and procedures were assessed as effective as of November 30, 2015.
Important Facts for Investors to Verify
- Whether the expected fourth-quarter Expeditionary Services recovery and airlift search-and-rescue contract materialize.
- Whether Aviation Services growth, particularly in defense programs, offsets continued commercial aftermarket softness.
- The conversion of increased receivables and inventory into operating cash flow and the level of unbilled defense receivables.
- Debt refinancing or repayment requirements, including the $35.3 million of current maturities and the March 2016 convertible notes maturity.
- The outcome and potential financial or contracting consequences of the DynCorp litigation and OIG investigation.
- The timing and proceeds of the planned PSM sale and any additional discontinued-operations charges or gains.
- The extent to which year-to-date earnings depend on the $27.7 million Telair contingent-consideration gain.