AAR CORP. Form 10-Q Summary
Reporting period: Quarter and nine months ended February 28, 2019, representing fiscal 2019 third quarter. Results are unaudited and should be read with the fiscal 2018 Form 10-K.
Business Context
AAR operates through Aviation Services, covering aviation supply chain and maintenance, repair and overhaul activities, and Expeditionary Services, covering manufacturing. Government-owned, contractor-operated activities, including the INL/A WASS program, were reclassified into Aviation Services for all periods presented. The COCO business is reported as discontinued operations.
Key Financial Metrics
| Metric | Q3 FY2019 | Q3 FY2018 | 9M FY2019 | 9M FY2018 |
|---|---|---|---|---|
| Sales | $529.5 million | $456.3 million | $1,489.1 million | $1,274.8 million |
| Gross profit | $85.3 million | $77.6 million | $234.8 million | $209.9 million |
| Gross margin | 16.1% | 17.0% | 15.8% | 16.5% |
| Operating income | $29.8 million | $24.2 million | $69.0 million | $63.2 million |
| Operating margin | 5.6% | 5.3% | 4.6% | 5.0% |
| Income from continuing operations | $27.4 million | $31.3 million | $57.5 million | $55.6 million |
| Net income (loss) | $(37.4) million | $15.5 million | $(15.3) million | $3.6 million |
| Diluted EPS | $(1.08) | $0.44 | $(0.45) | $0.08 |
Sales increased 16.0% in the quarter and 16.8% for the nine-month period. Aviation Services sales rose 15.9% in the quarter and 17.3% year to date, driven largely by government and defense growth from the INL/A WASS program. Expeditionary Services sales increased 17.9% in the quarter and 9.3% year to date, but gross profit declined.
Continuing-operations margins benefited from SG&A leverage but were pressured by product mix, MRO labor shortages, higher interest expense and a $12.4 million provision associated with a bankrupt European airline customer. The prior-year tax benefit included $14.8 million from the Tax Reform Act, making the year-over-year comparison less favorable.
Cash Flow, Liquidity and Debt
- Nine-month cash provided by operating activities was $24.5 million, including $16.4 million from continuing operations, compared with $32.9 million and $15.6 million, respectively, in the prior year.
- Operating cash flow was constrained by increases of $73.3 million in accounts receivable and $71.8 million in inventories.
- Capital expenditures were $12.3 million; cash used in investing activities was $13.8 million.
- Cash, cash equivalents and restricted cash totaled $50.4 million at February 28, 2019, including $28.9 million of unrestricted cash and $21.5 million of restricted cash.
- Working capital was $633.8 million. Management reported cash plus unused revolving-credit and accounts-receivable financing capacity of approximately $431 million.
- Total debt was $178.5 million before debt issuance costs, consisting primarily of $155.0 million drawn on the revolving facility and a $23.5 million term loan. Net long-term debt reported on the balance sheet was $177.2 million.
- The $500 million revolving credit facility had approximately $329.8 million of availability after $155.0 million of borrowings and $15.2 million of letters of credit. The company was in compliance with all debt covenants.
Material Changes and Unusual Items
- The company adopted ASC 606 on June 1, 2018 using the modified retrospective method, reducing opening retained earnings by $20.4 million. Reported results and working-capital classifications are therefore not fully comparable with prior periods.
- Revenue from certain repair, manufacturing and long-term contracts is now recognized over time. ASC 606 increased reported Q3 continuing-operations income by approximately $0.9 million and reduced nine-month continuing-operations income by approximately $0.9 million versus amounts excluding the standard.
- The COCO business generated a Q3 loss from discontinued operations of $64.8 million, including a $74.1 million impairment charge tied to expected proceeds from asset and contract sales. The nine-month discontinued-operations loss was $72.8 million.
- On March 15, 2019, AAR signed an agreement to sell certain COCO contracts and assets and expected closing before the end of calendar 2019. Discontinued-operations assets were $28.2 million and liabilities were $26.0 million at February 28, 2019.
- Inventory increased to $514.7 million from $460.7 million at May 31, 2018, while accounts payable increased to $218.6 million from $170.0 million.
Outlook, Risks and Contingencies
Management reported continued strength in Aviation Services and favorable long-term aftermarket trends, with growth from commercial and government customers. The INL/A WASS program reached full operational capability in June 2018, and operations in Costa Rica were expected to begin in the fourth quarter of fiscal 2019. No specific earnings or revenue guidance was provided.
Remaining performance obligations were approximately $1.2 billion at February 28, 2019, with about 40% expected to be recognized over the following 12 months. Backlog excludes unexercised options and potential IDIQ orders.
- MRO labor shortages constrained commercial gross profit and margins.
- Credit risk includes the European airline bankruptcy and broader collectability of receivables and contract assets.
- The company is exposed to variable interest rates, foreign-exchange movements, airline-industry conditions, government-contract changes, geopolitical events and credit-market conditions.
- The Department of Justice is investigating AAR Airlift Group under the civil False Claims Act concerning several U.S. government aviation contracts. The company is cooperating; the filing does not provide a loss estimate or resolution date.
- Most U.S. government contracts permit termination for convenience, subject to payment for work performed, certain costs and a reasonable profit.
- AAR expects to adopt the lease standard effective June 1, 2019 and does not anticipate a significant effect on operating results or cash flows, although the balance-sheet impact was still being evaluated.
Investor Verification Checklist
- Verify the timing, proceeds and final accounting for the COCO business sale and any additional impairment or gain.
- Assess whether Aviation Services growth, particularly INL/A WASS, offsets commercial MRO labor constraints and weaker Expeditionary Services margins.
- Monitor working-capital consumption, inventory levels, receivables collections and reliance on receivables sales for operating liquidity.
- Review the European airline bankruptcy exposure and the status and potential financial impact of the DOJ investigation.
- Reconcile reported results under ASC 606 with prior-period comparability and evaluate the effect of the upcoming lease-accounting adoption.