AAR CORP. Form 10-Q Summary
Business Context and Reporting Period
Unaudited quarterly report for the three months ended August 31, 2015, representing AAR’s first quarter of fiscal 2016. AAR operates through Aviation Services, which includes supply chain and maintenance, repair and overhaul activities, and Expeditionary Services, which includes airlift and mobility activities. Telair Cargo Group and Precision Systems Manufacturing were reported as discontinued operations.
Financial Performance and Position
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Continuing-operations sales | $377.8 million | $395.1 million | (4.4%) |
| Operating income | $14.8 million | $24.5 million | (39.6%) |
| Income from continuing operations attributable to AAR | $8.2 million | $11.8 million | (30.5%) |
| Net income attributable to AAR | $22.9 million | $14.4 million | +59.0% |
| Diluted EPS | $0.65 | $0.36 | +$0.29 |
| Operating cash flow | $(63.7) million | $15.0 million | $(78.7 million) |
Continuing-operations gross profit was $54.5 million, or approximately 14.4% of sales, compared with $62.4 million, or approximately 15.8%, in the prior-year quarter. Operating margin was approximately 3.9%, compared with 6.2% previously. The effective tax rate on continuing operations was 34.9%, versus 35.2%.
- Aviation Services sales increased 1.3% to $315.8 million, while gross profit increased 3.5% to $49.9 million. Its gross margin improved to 15.8% from 15.5%.
- Expeditionary Services sales declined 25.7% to $62.0 million, and gross profit declined 67.6% to $4.6 million. Gross margin fell to 7.4% from 17.0%.
- Net income benefited from a $27.7 million gain from contingent consideration related to the Telair Cargo Group sale. Discontinued operations otherwise recorded a $4.9 million operating loss.
- Cash and cash equivalents were $28.7 million at August 31, 2015, compared with $54.7 million at May 31, 2015. Working capital was $619.2 million.
- Total debt was $179.5 million, including $44.5 million of current maturities and $135.0 million of long-term debt. The company had $105.0 million outstanding under its revolving credit facility, approximately $13.5 million of letters of credit, and approximately $381.5 million of remaining availability.
Material Changes Versus the Prior Comparable Period
- Sales declined primarily because of lower Expeditionary Services demand. Defense mobility-product sales fell as the Department of Defense reduced purchases following reduced troop activity, and expeditionary airlift revenue declined because of fewer aircraft positions in Afghanistan after the troop drawdown.
- Aviation Services benefited from higher defense distribution volumes and a defense-related supply program, partially offset by weaker commercial aftermarket parts trading.
- Operating cash flow shifted to a $65.4 million use for continuing operations from $16.8 million provided in the prior-year quarter. The principal drivers were increases of $41.5 million in accounts receivable and $22.2 million in inventory.
- Interest expense fell to $2.0 million from $6.4 million, primarily because AAR redeemed its $325 million, 7.25% Senior Notes in the fourth quarter of fiscal 2015.
- AAR repurchased $14.4 million principal amount of convertible notes for $14.6 million cash and recorded a $0.3 million loss on extinguishment. It also spent $7.1 million on treasury-stock purchases and paid $2.6 million in dividends.
- Cash from discontinued-operation investing activities included approximately $28.3 million of contingent consideration proceeds from the Telair sale.
Outlook, Commentary, Risks and Unusual Items
Management described a multi-phase transformation focused on narrowing the company’s strategic focus, strengthening the balance sheet, reducing overhead, consolidating MRO operations, and growing the remaining Aviation Services and Expeditionary Services businesses. The filing does not provide specific quantitative revenue or earnings guidance.
- Management expects to use the strengthened balance sheet to grow the remaining businesses during fiscal 2016.
- Management intends to fund current debt maturities through cash on hand and borrowings under the revolving credit facility.
- Accounts receivable included $28.8 million of unbilled amounts related to a defense supply program, compared with $21.1 million at May 31, 2015. Inventory increased partly because of new distribution contracts and weaker-than-expected aftermarket demand.
- AAR was in compliance with all debt covenants. Financing covenants include restrictions relating to dividends, leverage, interest coverage, asset sales, additional financing, and share repurchases.
- A lawsuit filed by DynCorp alleges that AAR Airlift misappropriated proprietary information in connection with proposals for a U.S. Department of State aviation-support program. AAR denies the allegations and intends to defend the matter. A related Department of State Inspector General investigation was ongoing as of the filing.
- Key market risks include interest-rate fluctuations, foreign-exchange movements, customer credit exposure, general economic conditions, airline-industry conditions, geopolitical events, government and defense spending, and operating performance.
- The company adopted expanded discontinued-operations presentation guidance and was evaluating the future effects of new revenue-recognition and debt-issuance-cost standards.
Important Facts for Investors to Verify
- Whether the sharp decline in Expeditionary Services demand and margins stabilizes or persists.
- Whether working-capital investments in receivables and inventory convert into operating cash flow.
- The timing and funding of the $44.5 million of current debt maturities and the continued availability of the revolving credit facility.
- The resolution and potential financial or contract impact of the DynCorp litigation and related government investigation.
- The status and proceeds from the planned sale of the Precision Systems Manufacturing business.
- The extent to which the $27.7 million contingent-consideration gain inflated reported net income and EPS relative to recurring continuing operations.