AAR CORP. Form 10-K Summary
Business context and reporting period
This filing is AAR CORP.’s Form 10-K for the fiscal year ended May 31, 2018. The requested “2017 Q4” period does not match the filing period; the filing includes fiscal 2018 annual results and fiscal fourth-quarter data. AAR provides aviation aftermarket products and services to commercial aviation, government, and defense customers through Aviation Services and Expeditionary Services.
- Aviation Services represented 93% of fiscal 2018 sales and includes aviation supply chain, parts distribution, MRO, engineering, and landing gear services.
- Expeditionary Services represented 7% of sales and includes airlift, mobility products, pallets, shelters, containers, and related engineering.
- Major developments included the ramp-up of a 15-year U.S. Air Force landing gear logistics program and commencement of the 10-year Department of State WASS contract.
Financial results and key metrics
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Sales | $1,748.3 million | $1,590.8 million | +9.9% |
| Gross profit | $294.6 million | $263.4 million | +11.8% |
| Gross margin | 16.9% | 16.6% | +0.3 points |
| Operating income | $86.0 million | $82.3 million | +4.5% |
| Operating margin | 4.9% | 5.2% | Down approximately 0.3 points |
| Income from continuing operations | $73.7 million | $52.0 million | +41.7% |
| Net income | $15.6 million | $56.5 million | Down 72.4% |
| Diluted EPS from continuing operations | $2.11 | $1.51 | +39.7% |
| Diluted EPS | $0.41 | $1.64 | Down 75.0% |
| Operating cash flow | $64.3 million | $21.8 million | +195.4% |
| Operating cash flow from continuing operations | $55.8 million | $(13.5) million | Improved $69.3 million |
- Fiscal 2018 sales consisted of $1,040.7 million of product sales and $707.6 million of service sales.
- Aviation Services sales increased 9.0% to $1,618.9 million; commercial sales rose 15.0%, while government and defense sales declined 9.0% primarily due to the KC-10 program wind-down.
- Expeditionary Services sales increased 22.8% to $129.4 million, primarily due to the WASS program.
- Fiscal 2018 SG&A increased 15.2% to $208.6 million, reflecting higher personnel and business-development costs. Interest expense increased to $8.0 million from $5.3 million.
- Cash and cash equivalents were $31.1 million, with restricted cash of $10.5 million. Working capital was $609.4 million and total assets were $1,524.7 million.
- Total debt was $178.9 million, including $130.0 million outstanding under the revolving credit facility, $23.9 million under a Canadian term loan, and a $25.0 million industrial revenue bond.
- The revolving credit facility had $353.3 million of availability after borrowings and letters of credit. Including cash and unused revolving and receivables-financing capacity, management reported approximately $473 million of liquidity.
- Capital expenditures for continuing operations were $22.0 million, and $22.9 million was paid for the acquisition of two Canadian MRO facilities.
Material changes versus the prior comparable period
- Growth was driven by aviation supply-chain contract awards, including commercial and government component inventory-management and repair programs.
- The KC-10 program declined to $29.1 million of sales from $110.6 million in fiscal 2017 and $148.1 million in fiscal 2016.
- Commercial aviation gross margin in Aviation Services declined to 15.9% from 16.4%, primarily because of labor challenges at airframe-maintenance hangars. Government and defense gross margin improved to 20.2% from 17.0%.
- Income from continuing operations benefited from a $14.1 million deferred-tax remeasurement benefit related to the Tax Cuts and Jobs Act and a $2.9 million excess tax benefit from share-based compensation. The effective tax rate fell to 4.5% from 32.6%.
- The company classified its Contractor-Owned, Contractor-Operated business as discontinued operations. Fiscal 2018 included a $58.1 million loss from discontinued operations, including $65.2 million of pre-tax impairment charges, compared with $4.5 million of income in fiscal 2017.
- Backlog increased to approximately $1.053 billion from $519 million, with approximately $510 million expected to be filled in fiscal 2019.
- Sales to government and defense customers declined to $428.8 million, or 24.5% of consolidated sales, from $438.7 million, or 27.6%. U.S. government and contractor sales declined to $304.3 million from $321.5 million.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected fiscal 2019 consolidated sales of $2.1 billion to $2.2 billion and diluted EPS from continuing operations of $2.50 to $2.80.
- Management cited favorable aftermarket trends, contract wins, and continued growth in commercial and government businesses, while planning opportunistic investment and continued shareholder returns.
- The company adopted or planned accounting changes affecting revenue recognition, including an expected approximately $20 million decrease to retained earnings upon adoption on June 1, 2018. Certain manufacturing, repair, and percentage-of-completion contracts will be recognized differently under the new standard.
- Key operating risks include commercial aviation cyclicality, customer bankruptcies and credit risk, dependence on airline outsourcing, government funding and contract renewals, fixed-price contract cost overruns, competitive bidding and bid protests, regulatory compliance, skilled-labor availability, cybersecurity, international operations, foreign exchange, and potential asset or goodwill impairments.
- The Department of Justice was investigating AAR’s Airlift subsidiary under the civil False Claims Act regarding certain U.S. Transportation Command and U.S. Navy contracts. A former employee’s related qui tam lawsuit remained under seal, and the company was cooperating.
- A DynCorp lawsuit concerning alleged misuse of information in connection with the WASS contract was settled confidentially in June 2018 without payment by either party and dismissed with prejudice.
- Purchase obligations totaled $253.9 million, including $203.4 million due in fiscal 2019. Operating lease obligations totaled $94.8 million, and letters of credit and performance bonds totaled approximately $16.7 million.
- Management and KPMG reported effective disclosure controls and internal control over financial reporting. KPMG issued unqualified opinions on the financial statements and internal controls.
Most important facts for an investor to verify
- Reconcile reported fiscal 2019 guidance with actual contract ramp-up, particularly the WASS and U.S. Air Force landing gear programs.
- Assess whether the large backlog converts to revenue and cash as expected, including the approximately $510 million expected in fiscal 2019.
- Separate recurring operating earnings from the fiscal 2018 tax benefits and the substantial discontinued-operation impairments.
- Monitor cash conversion, receivables sales, restricted cash, inventory and rotable-asset investment, and the resulting dependence on working-capital financing.
- Review the outcome and potential financial exposure of the Department of Justice False Claims Act investigation.
- Evaluate government-budget, contract-renewal, fixed-price, regulatory, labor, cybersecurity, and commercial-airline demand risks.
- Confirm the financial statement effects of the new revenue-recognition standard and whether the projected approximately $20 million retained-earnings reduction was finalized.