AAR CORP. Form 10-Q Summary
Business context and reporting period
AAR CORP. reported results for the three and six months ended November 30, 2018, the second quarter and first six months of fiscal 2019. The company operates through Aviation Services, providing aftermarket supply-chain and maintenance, repair and overhaul services, and Expeditionary Services, focused primarily on manufacturing. Segment presentation was realigned in fiscal 2019, with the government-owned, contractor-operated INL/A WASS business moved into Aviation Services for all periods.
Key financial metrics
| Metric | Three months ended Nov. 30, 2018 | Year-over-year change | Six months ended Nov. 30, 2018 | Year-over-year change |
|---|---|---|---|---|
| Sales | $493.3 million | +17.3% | $959.6 million | +17.2% |
| Gross profit | $78.3 million | +$7.6 million | $149.5 million | +$17.2 million |
| Gross margin | 15.9% | Down from 16.8% | 15.6% | Down from 16.2% |
| Operating income | $16.8 million | Down from $21.8 million | $39.2 million | Up from $38.9 million |
| Income from continuing operations | $11.2 million | Down from $13.2 million | $30.1 million | Up from $24.2 million |
| Net income | $7.0 million | Compared with $(22.6) million | $22.1 million | Compared with $(12.0) million |
| Diluted EPS | $0.20 | Compared with $(0.66) | $0.62 | Compared with $(0.35) |
Aviation Services sales increased 18.2% in the quarter and 18.1% year to date, primarily from government and defense growth associated with the INL/A WASS program. Aviation Services gross margin was approximately 16.2% in the quarter and 15.8% year to date. Expeditionary Services sales increased 5.2% in the quarter and 5.0% year to date, while its gross margin declined to 11.2% and 12.9%, respectively.
SG&A was $49.1 million in the quarter and $97.3 million year to date, representing 10.0% and 10.1% of sales, respectively. The provision for doubtful accounts was $12.4 million in the quarter and year to date. Interest expense was $2.5 million in the quarter and $4.6 million year to date. Effective tax rates on continuing operations were 21.1% for the quarter and 15.0% year to date, benefiting from the Tax Cuts and Jobs Act and excess tax benefits from equity compensation.
Cash used in operating activities was $35.5 million for the first six months, including $41.2 million used by continuing operations. Cash used in investing activities was $9.4 million, and cash provided by financing activities was $44.2 million. Cash, cash equivalents, and restricted cash totaled $40.7 million at November 30, 2018, including $25.7 million of unrestricted cash.
Total debt was $220.3 million before debt issuance costs, compared with $178.9 million at May 31, 2018. Long-term debt, net of issuance costs, was $218.9 million. Revolver borrowings were $197.0 million under a $500 million facility; approximately $15.2 million of letters of credit reduced reported availability to $287.8 million. Foreign credit lines provided an additional $9.6 million of availability. The company reported compliance with all debt covenants.
Material changes versus the prior comparable period
- Revenue growth was driven principally by the INL/A WASS contract, which reached full operational capability in June 2018, and by higher commercial supply-chain demand.
- Commercial Aviation Services gross profit declined 5.9% in the quarter and 4.6% year to date because of lower MRO volumes; related margins fell to 14.3% and 14.1%.
- Expeditionary Services gross profit declined 27.7% in the quarter and 11.8% year to date, primarily because of product mix.
- Second-quarter operating income declined despite higher sales because of the $12.4 million doubtful-account provision related to the bankruptcy of a European airline customer. The charge included $7.6 million of non-current contract-asset impairment, $3.3 million of receivable allowances, and $1.5 million of other liabilities.
- Net income improved substantially because the prior-year comparison included a $54.2 million impairment and other charge from discontinued COCO operations. The COCO business generated an $8.0 million loss in the first six months of fiscal 2019, compared with a $36.2 million loss in the prior-year period.
- ASC 606 revenue recognition was adopted on June 1, 2018 using the modified retrospective method, reducing opening retained earnings by $20.4 million. Reported six-month income from continuing operations was $1.6 million higher than the amount excluding the adoption adjustments.
- Working capital increased, including inventories of $495.0 million versus $460.7 million at May 31, 2018 and accounts receivable of $218.6 million versus $202.0 million.
Guidance, outlook, risks, contingencies, and unusual items
Management stated that it continues to see strength in Aviation Services and favorable long-term aftermarket trends. The company expects to invest opportunistically in commercial aviation and government and defense capabilities. Management reported approximately $380 million of cash plus unused revolving-credit and accounts-receivable-financing capacity at November 30, 2018.
Remaining performance obligations were approximately $1.3 billion, excluding unexercised options and potential IDIQ orders. Approximately 40% was expected to be recognized as revenue within 12 months, with most of the remainder recognized over the following three years.
The COCO discontinued business was being actively marketed and management expected a sale before the end of fiscal 2019. The business remained classified as held for sale, with $109.9 million of assets and $24.6 million of liabilities at November 30, 2018. The filing also disclosed a Department of Justice investigation under the civil False Claims Act involving AAR Airlift contracts in Afghanistan, Africa, and U.S. Navy operations; the company was cooperating, and the related qui tam lawsuit remained under seal.
Key risks include airline and defense-market conditions, government contract performance and funding, customer credit losses, working-capital requirements, variable interest rates, foreign exchange exposure, and execution of long-term cost-to-cost contracts. The company stated that no material changes had occurred to the risk factors in its fiscal 2018 Form 10-K. The filing did not provide fiscal 2019 quantitative earnings or revenue guidance.
Facts investors should verify
- Whether the INL/A WASS program sustains Aviation Services growth and improves overall margins.
- The collectibility of balances and contract assets associated with the bankrupt European airline customer.
- Inventory, receivables, and contract-asset growth relative to sales and operating cash flow.
- Progress, valuation, and final proceeds from the planned COCO business sale.
- Potential financial, contractual, or reputational effects of the Department of Justice investigation.
- The effects of ASC 606 and the upcoming June 1, 2019 lease-accounting adoption on reported results and leverage.
- Revolver utilization, interest-rate exposure, covenant compliance, and continued access to receivables financing.