AAR CORP. Form 10-Q Summary
Business context and reporting period
This unaudited Form 10-Q covers the three months ended August 31, 2018, AAR’s first quarter of fiscal 2019, with comparison to the three months ended August 31, 2017. AAR operates through Aviation Services, providing aviation aftermarket, supply-chain, MRO and fleet-support services, and Expeditionary Services, providing military and aerospace manufacturing products.
The government-owned, contractor-operated business, including the INL/A WASS program, was reclassified from Expeditionary Services to Aviation Services for all periods presented. The Company is pursuing the sale of its contractor-owned, contractor-operated business, which is reported as discontinued operations.
Financial performance and key metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Sales | $466.3 million | $397.9 million | 17.2% increase |
| Gross profit | $71.2 million | $61.6 million | 15.6% increase |
| Gross margin | 15.3% | 15.5% | Down approximately 0.2 points |
| Operating income | $22.4 million | $17.1 million | 31.0% increase |
| Operating margin | 4.8% | 4.3% | Improved |
| Income from continuing operations | $18.9 million | $11.0 million | 71.8% increase |
| Net income | $15.1 million | $10.6 million | 42.5% increase |
| Diluted EPS from continuing operations | $0.54 | $0.32 | Increase |
| Diluted EPS | $0.43 | $0.31 | Increase |
Aviation Services sales rose 18.1% to $438.4 million, primarily because government and defense sales increased 76.8% to $131.7 million as the INL/A WASS program reached full operational capability. Expeditionary Services sales increased 4.9% to $27.9 million.
SG&A increased to $48.8 million from $44.5 million, but declined to 10.5% of sales from 11.2%. Interest expense increased to $2.1 million from $1.7 million. The continuing-operations effective tax rate declined to 10.8% from 28.6%, principally due to the Tax Cuts and Jobs Act and higher excess tax benefits from equity compensation.
Cash flow, liquidity and debt
- Cash used in operating activities was $27.0 million, including $32.9 million used by continuing operations, compared with total operating cash use of $20.6 million in the prior-year quarter.
- Operating cash flow from continuing operations was pressured by a $24.5 million increase in inventories and a $20.7 million increase in accounts receivable.
- Cash used in investing activities was $5.0 million, including $4.2 million of capital expenditures.
- Cash provided by financing activities was $35.3 million, including $57.0 million of short-term borrowings and $25.0 million of long-term debt repayments.
- Cash, cash equivalents and restricted cash totaled $44.8 million at August 31, 2018, including unrestricted cash of $22.7 million and restricted cash of $22.1 million.
- Working capital was $667.3 million. Management reported cash plus unused revolving-credit and accounts-receivable financing capacity of approximately $403 million.
- Total debt was $210.7 million before debt issuance costs, compared with $178.9 million at May 31, 2018. The increase primarily reflects use of the revolving facility to repay a $25.0 million industrial revenue bond.
- The $500 million revolving credit facility had $187.0 million drawn, approximately $16.6 million of outstanding letters of credit, and approximately $296.4 million of availability. An additional $9.7 million was available under foreign credit lines.
- The Company was in compliance with all financing covenants at August 31, 2018.
Material changes, accounting and unusual items
- AAR adopted ASC 606 using the modified retrospective method on June 1, 2018. The adoption reduced opening retained earnings by $20.4 million and changed the timing and presentation of certain product and service revenues.
- For the current quarter, reported ASC 606 adoption effects reduced sales by $4.8 million and continuing-operations income by $2.4 million compared with balances excluding the standard. The filing indicates no impact on net operating cash flow from these adjustments.
- ASC 606 resulted in $48.8 million of current contract assets at August 31, 2018. Remaining performance obligations were approximately $1.65 billion, with approximately 50% expected to be recognized as revenue over the next 12 months.
- The Company recognized a $3.8 million loss from discontinued operations, compared with a $0.4 million loss in the prior-year quarter. Discontinued-operation sales declined to $20.0 million from $41.3 million.
- The COCO business had $114.7 million of assets and $24.7 million of liabilities classified as discontinued operations at August 31, 2018. Management expected the sale to be completed before the end of fiscal 2019.
- The first quarter included net favorable cumulative catch-up adjustments of $0.2 million on certain long-term power-by-the-hour programs.
- The Company adopted new pension-cost presentation guidance, resulting in $0.3 million of pension income in other income, net.
Guidance, outlook, commentary and risks
Management expected continued strength in Aviation Services, supported by favorable long-term aftermarket trends, commercial and government contract wins, and the ramp-up of the U.S. Air Force Landing Gear Performance-Based Logistics One program. Fiscal 2019 consolidated sales guidance was $2.1 billion to $2.2 billion, and diluted EPS from continuing operations guidance was $2.50 to $2.80.
The Department of Justice is investigating AAR Airlift Group under the civil False Claims Act concerning performance of aircraft operations and maintenance contracts in Afghanistan, Africa and under several U.S. Navy contracts. The Company is cooperating; the filing does not provide a clear estimate of potential financial exposure.
Key risks include government contract performance and termination, aviation and defense demand, working-capital requirements, variable interest rates, foreign exchange, credit losses, execution of long-term programs, the planned sale of the COCO business, and estimates used for cost-to-cost revenue recognition. The filing states that there were no material changes to the risk factors in the fiscal 2018 Form 10-K.
Important facts for investors to verify
- Confirm the continuing relevance of the $2.1 billion to $2.2 billion sales and $2.50 to $2.80 diluted EPS guidance.
- Monitor conversion of the approximately $1.65 billion backlog into revenue and cash flow.
- Assess inventory and receivables growth, given negative continuing-operating cash flow in the quarter.
- Track debt balances, borrowing costs, covenant compliance and remaining revolver availability.
- Review the financial impact and timing of the COCO business sale, including potential additional losses or impairment.
- Follow developments in the Department of Justice investigation and any related contingency disclosures.
- Evaluate the comparability of current results after ASC 606 adoption and the effect of future cost-to-cost estimate changes.