AAR CORP. Form 10-Q Summary
Reporting period: Third quarter and first nine months of fiscal 2020 ended February 29, 2020, compared with the corresponding periods ended February 28, 2019. The filing is identified in the request as “2019 Q3,” but the filing period is fiscal 2020 Q3. Results are unaudited.
Business context
AAR operates through Aviation Services, which provides aviation aftermarket parts, supply-chain management and maintenance, repair and overhaul services, and Expeditionary Services, which primarily manufactures defense-related pallets, shelters, containers and composite products. The former contractor-owned, contractor-operated business is reported as discontinued operations.
Key financial metrics
| Metric | Q3 FY2020 | Q3 FY2019 | 9M FY2020 | 9M FY2019 |
|---|---|---|---|---|
| Sales | $553.1 million | $529.5 million | $1,655.5 million | $1,489.1 million |
| Operating income | $5.3 million | $29.8 million | $56.2 million | $69.0 million |
| Income from continuing operations | $2.6 million | $27.4 million | $39.8 million | $57.5 million |
| Net income (loss) | $2.3 million | $(37.4) million | $20.9 million | $(15.3) million |
| Diluted EPS | $0.06 | $(1.08) | $0.59 | $(0.45) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $(8.9) million | $24.5 million |
Margins: Consolidated operating margin was approximately 1.0% in Q3 FY2020 versus 5.6% in Q3 FY2019, and approximately 3.4% for the first nine months versus 4.6% in the prior-year period. Consolidated gross profit was $65.3 million in Q3 and $232.8 million for the first nine months, compared with $85.3 million and $234.8 million, respectively.
- Aviation Services: Q3 sales increased 6.6% to $530.3 million, while gross profit declined 20.2% to $65.2 million. Nine-month sales increased 12.5% to $1.574 billion and gross profit increased 3.2% to $230.9 million.
- Expeditionary Services: Q3 sales declined 29.2% to $22.8 million and gross profit declined 97.2% to $0.1 million. Nine-month sales declined 10.1% to $81.4 million and gross profit declined 82.9% to $1.9 million.
- Balance sheet: At February 29, 2020, cash and cash equivalents were $37.0 million, restricted cash was $27.9 million, total assets were $1.829 billion and total equity was $929.4 million.
- Debt and liquidity: Debt carrying value was $206.0 million, consisting primarily of $185.0 million outstanding under the revolving credit facility and a $23.1 million term loan. The revolving facility had a $600 million commitment, approximately $20.3 million of letters of credit and reported availability of $394.7 million. Management reported cash plus unused revolver capacity of $432 million and an additional $92 million available under the receivables financing program.
- Backlog: Remaining performance obligations were approximately $1.1 billion, with approximately 40% expected to be recognized over the following 12 months.
Material changes versus the prior comparable period
- Revenue increased 4.5% in Q3 and 11.2% for the first nine months, driven primarily by Aviation Services and recently awarded government and defense contracts.
- Q3 profitability deteriorated materially. Aviation Services recorded a $24.7 million charge related to the termination and restructuring of commercial power-by-the-hour contracts, including a $9.8 million reduction in contract assets and revenue and $14.9 million of forward loss reserves and related costs.
- Expeditionary Services experienced lower sales and substantially reduced gross profit because of contract timing and operational challenges.
- Operating cash flow from continuing operations declined to an outflow of $0.5 million from $16.4 million of inflow, primarily due to working-capital changes and customer invoice collection timing. Total operating cash flow was an $8.9 million outflow, including discontinued operations.
- Debt increased from $141.7 million of long-term debt at May 31, 2019 to $206.0 million at February 29, 2020, primarily reflecting increased revolver borrowings.
- The company adopted ASC 842 lease accounting on June 1, 2019, recognizing operating lease right-of-use assets and liabilities; management stated that the adoption did not materially affect operations or cash flows.
- Discontinued operations produced a $0.3 million loss in Q3 and an $18.9 million loss for the first nine months, compared with losses of $64.8 million and $72.8 million, respectively, in the prior-year periods. The prior year included a $74.1 million impairment charge.
Outlook, risks and unusual items
- Management expects COVID-19 to negatively affect commercial aviation activity, revenues and results because of reduced aircraft flying and flight hours, supply-chain disruption and broader economic effects. The filing does not provide a quantified revenue or earnings forecast.
- In response to COVID-19, AAR planned fixed-cost and overhead reductions, including facility consolidation, executive compensation reductions, a hiring freeze, reduced discretionary spending, furloughs and workforce reductions. Expected fourth-quarter costs were approximately $15 million to $20 million, with stated payback within one year.
- Subsequent to quarter-end, AAR drew $165 million on its revolving credit facility as a precautionary measure, with most of the proceeds remaining in cash.
- AAR reported compliance with its debt covenants as of February 29, 2020. Its financing agreements include leverage, interest coverage, working-capital and other restrictive covenants.
- A Department of Justice investigation under the civil False Claims Act involves certain AAR Airlift contracts. Management believes a loss is probable but cannot reasonably estimate the maximum potential loss; an adverse resolution could be material and may involve treble damages and penalties.
- The company self-reported possible Code of Conduct, Foreign Corrupt Practices Act and other legal violations relating to activities in Nepal and South Africa to the Department of Justice, SEC and UK Serious Fraud Office. The potential outcome is not currently predictable.
- Disclosure controls and procedures were not effective as of February 29, 2020 because of previously reported material weaknesses involving inventory cycle counts, information technology general controls and vendor master-file changes. Remediation was ongoing, with completion anticipated by the end of fiscal 2020.
Most important facts for investors to verify
- COVID-19’s effect on commercial aviation demand, customer contracts, supply chains, revenue and liquidity.
- The cost, timing and effectiveness of the planned $15 million to $20 million cost-reduction actions.
- The outcome and potential financial exposure from the Department of Justice investigation and the self-reported compliance matters.
- Progress in remediating material weaknesses in internal control over financial reporting.
- Cash conversion, inventory growth, receivables collections and continued use of receivables sales financing.
- Profitability and contract-loss exposure in commercial power-by-the-hour programs and operational performance in Expeditionary Services.
- Revolver utilization, covenant headroom, variable-rate exposure and post-quarter-end liquidity following the $165 million draw.