AAR CORP. Form 10-Q Summary
Reporting period: Quarter and six months ended November 30, 2019, representing the second quarter and first six months of fiscal 2020. The interim financial statements are unaudited. AAR operates through Aviation Services and Expeditionary Services.
Financial performance and position
| Metric | Three months ended Nov. 30, 2019 | Prior year | Six months ended Nov. 30, 2019 | Prior year |
|---|---|---|---|---|
| Sales | $560.9 million | $493.3 million | $1,102.4 million | $959.6 million |
| Operating income | $28.1 million | $16.8 million | $50.9 million | $39.2 million |
| Income from continuing operations | $20.1 million | $11.2 million | $37.2 million | $30.1 million |
| Net income | $14.2 million | $7.0 million | $18.6 million | $22.1 million |
| Diluted EPS | $0.40 | $0.20 | $0.53 | $0.62 |
- Second-quarter sales increased 13.7%; six-month sales increased 14.9%. Operating margins were approximately 5.0% and 4.6%, respectively, compared with approximately 3.4% and 4.1% in the prior-year periods.
- Continuing-operations income increased despite a higher effective tax rate: 23.0% in the quarter versus 21.1%, and 20.2% for six months versus 15.0%.
- Net income was reduced by losses from discontinued operations of $5.9 million in the quarter and $18.6 million for six months, compared with $4.2 million and $8.0 million, respectively, in the prior year.
- Aviation Services sales increased 14.9% in the quarter and 15.8% for six months. Aviation gross profit increased 14.4% and 16.7%, respectively.
- Expeditionary Services sales declined 4.9% in the quarter and were essentially flat for six months. Gross profit fell 94.1% in the quarter and 76.0% for six months, reflecting operational challenges; quarterly gross margin declined to 0.7% from 11.2%.
- Cash and cash equivalents were $38.2 million at November 30, 2019, compared with $21.3 million at May 31, 2019. Working capital was $665.7 million.
- Cash used in operating activities was $17.9 million for six months, including $10.2 million from continuing operations, versus $35.5 million and $41.2 million, respectively, in the prior year. Inventory increased to $580.4 million from $523.7 million at May 31, 2019.
- Cash used in investing activities was $11.7 million, including $10.2 million of property and equipment expenditures. Financing activities provided $41.1 million, primarily from $55.0 million of short-term borrowings.
- Total debt was $198.3 million before debt issuance costs, up from $142.9 million at May 31, 2019. Revolver borrowings were $175.0 million, and the term loan balance was $23.3 million.
- The revolving credit commitment was increased to $600 million and extended to September 25, 2024. Availability was approximately $404.7 million after borrowings and letters of credit. Management reported compliance with all financing covenants.
Material changes and unusual items
- AAR adopted ASC 842 lease accounting on June 1, 2019, recognizing operating lease right-of-use assets and liabilities. At November 30, 2019, operating lease liabilities totaled $97.7 million, including $84.0 million classified as non-current. The adoption had no material income-statement or cash-flow impact.
- Discontinued operations relate primarily to the Contractor-Owned, Contractor-Operated business. A $11.8 million impairment charge was recorded in the first quarter of fiscal 2020. The sale of DoD contracts and related assets was completed in the second quarter; the remaining operating contract was expected to be sold after government approval before fiscal year-end.
- Second-quarter results included favorable cumulative catch-up adjustments of $1.9 million on long-term programs, compared with $3.1 million in the prior year. Six-month net favorable adjustments were $1.9 million versus $3.3 million in the prior year.
- Second-quarter SG&A increased $8.0 million, including $2.4 million of investigation and remediation compliance costs and $0.9 million of severance costs. Six-month compliance and severance costs were $5.2 million and $1.7 million, respectively.
- AAR sold $404.8 million of receivables during the six months under its receivables-financing program and incurred $1.1 million of related discounts and fees.
- The company repurchased 100,000 shares during October 2019 for $40.84 per share. Approximately $222.5 million remained available under the $250 million repurchase authorization.
Outlook, risks and contingencies
- Management expects continued strength in Aviation Services, citing new commercial and government contracts and favorable long-term aftermarket trends. Approximately $1.3 billion of remaining performance obligations existed at November 30, 2019; about 40% was expected to be recognized as revenue within 12 months.
- Management stated that the company had $522 million of cash, unused revolver capacity and accounts-receivable financing capacity and intended to invest opportunistically in growth.
- The Department of Justice is investigating AAR Airlift Group under the civil False Claims Act regarding aircraft operations and maintenance contracts. Settlement discussions are underway. Management believes a loss is probable but cannot reasonably estimate the maximum exposure; treble damages and penalties could apply if litigation proceeds.
- AAR self-reported potential Foreign Corrupt Practices Act and other legal violations relating to activities in Nepal and South Africa to the DOJ, SEC and UK Serious Fraud Office. The filing does not provide a clear estimate of any potential financial impact.
- Disclosure controls and procedures were not effective as of November 30, 2019 because of previously reported material weaknesses in internal control over financial reporting. Inventory-count remediation was substantially advanced, while information-technology general controls and vendor-master-file controls remained under remediation, expected to be completed by the end of fiscal 2020.
- Key operating risks include execution challenges in Expeditionary Services, lower margins on newer government contracts, working-capital requirements, airline and credit-market conditions, foreign exchange, variable interest rates and customer credit losses. Past-due receivables from former commercial program customers totaled $10.1 million, net of a $6.2 million allowance.
Important facts for investors to verify
- Progress and costs associated with the DOJ False Claims Act investigation and the self-reported Nepal and South Africa matters.
- Whether Expeditionary Services operational issues improve and whether its margins recover.
- Conversion of backlog and contract liabilities into revenue and cash, including the profitability of newer government awards.
- Inventory growth, operating cash flow and continued reliance on receivables sales and revolver borrowings.
- Completion and effectiveness testing of remediation for the disclosed material weaknesses.
- Completion of the remaining discontinued-operation asset sale and any further impairment, litigation or transition costs.