AAR CORP. Form 10-Q Summary
Business context and reporting period
AAR CORP. reported its fiscal second quarter and first six months ended November 30, 2016. The company operates through Aviation Services, which includes aviation parts, supply chain and MRO activities, and Expeditionary Services, which includes airlift, mobility products and related services. The interim financial statements are unaudited and prepared under U.S. GAAP.
Key financial metrics
| Metric | Three months ended November 30, 2016 | Three months ended November 30, 2015 | Six months ended November 30, 2016 | Six months ended November 30, 2015 |
|---|---|---|---|---|
| Sales | $423.8 million | $431.5 million | $828.6 million | $818.2 million |
| Operating income | $19.9 million | $15.9 million | $36.6 million | $29.5 million |
| Income from continuing operations | $12.1 million | $9.2 million | $22.0 million | $16.6 million |
| Net income | $12.1 million | $8.0 million | $21.6 million | $30.9 million |
| Diluted EPS | $0.35 | $0.23 | $0.63 | $0.89 |
- Margins: Consolidated gross margin was approximately 15.6% in the quarter and 15.4% year to date, compared with approximately 13.7% and 13.8%, respectively, in the prior-year periods. Operating margin was approximately 4.7% for the quarter and 4.4% year to date.
- Segment performance: Second-quarter Aviation Services sales declined 3.6% to $346.7 million, while gross profit declined 3.8% to $56.0 million. Expeditionary Services sales increased 7.2% to $77.1 million, and gross profit increased to $10.2 million from $0.9 million. Six-month segment gross profit increased 1.2% in Aviation Services and 273.5% in Expeditionary Services.
- Cash flow: Cash used in operating activities was $1.2 million for the six months, including $0.3 million from continuing operations, compared with $15.9 million used in total operating activities in the prior-year period. Continuing-operations cash flow was constrained by a $47.9 million increase in equipment held for long-term lease.
- Investing and financing: Investing activities used $3.7 million. Financing activities used $2.8 million, including $5.2 million of dividends and $14.8 million of treasury-stock purchases, partially offset by $19.0 million of net short-term borrowings.
- Liquidity and debt: Cash was $23.0 million at November 30, 2016, compared with $31.2 million at May 31, 2016. Total debt was $163.3 million, including $129.0 million drawn under the revolving facility. The $500 million facility had approximately $357.0 million of availability after borrowings and letters of credit; foreign lines of credit added $9.3 million. Management reported cash plus unused revolving capacity of approximately $380 million and compliance with all debt covenants.
- Balance sheet: Working capital was $550.9 million. Accounts receivable increased to $276.5 million and inventory to $459.5 million from May 31, 2016. Total equity was $872.4 million.
Material changes versus the prior comparable period
- Quarterly sales decreased 1.8%, but operating income increased 25.2% and diluted EPS increased from $0.23 to $0.35, primarily reflecting stronger Expeditionary Services profitability and lower interest expense.
- Six-month sales increased 1.3% and operating income increased 24.1%. Continuing-operations income increased 32.5%, but net income declined 30.1% because the prior-year period included a $27.7 million gain from contingent consideration related to the Telair Cargo Group sale.
- Commercial Aviation Services sales increased, supported by aftermarket parts trading and distribution, while government and defense sales declined. Aviation Services results were also affected by the wind-down of the KC10 logistics program and the transition of the Lake Charles facility to a more limited operation.
- Expeditionary Services gross profit improved materially due to stronger airlift results, mobility products and the reclassification of composite manufacturing into continuing operations.
- SG&A increased $3.2 million in the quarter and $8.0 million year to date due primarily to increased business-development investment.
- AAR sold certain temperature-controlled container assets for $5.0 million and recognized a $2.6 million gain. The company retained a three-year manufacturing supply agreement with the buyer.
Outlook, commentary, risks and unusual items
- Management expects revenue and income from recently awarded commercial aviation programs to begin ramping in the second half of fiscal 2017. The company invested approximately $31 million in rotable assets during the quarter to support these programs.
- The U.S. Air Force awarded the KC10 Extender logistics-support program to a competitor. AAR expected to provide transition services through January 2017, followed by diminished services for an unspecified period. Fiscal 2016 KC10 revenue and gross profit were $148.1 million and $16.0 million, respectively.
- The Department of State awarded AAR the GASS contract, with a potential duration of eleven years and a stated ceiling of $10 billion including related task orders. The incumbent contractor’s protest was denied by the Government Accountability Office.
- Government markets supporting troop movements remained weak, and existing airlift contract positions were affected by expirations and transitions. Commercial aviation demand was described as healthy.
- AAR Airlift faces renewed litigation from DynCorp alleging trade-secret misappropriation related to the GASS proposal. On November 21, 2016, the Eleventh Circuit reversed dismissal of the complaint and remanded the matter for further proceedings. Management believes the claims are without merit.
- Discontinued operations included the Telair Cargo Group and the PSM metal-machining operation. Composite manufacturing was moved into continuing operations. The prior-year comparison includes significant discontinued-operation gains that do not recur.
- No formal earnings guidance was provided in the filing. Management cautioned that interim results are not necessarily indicative of full-year results and identified exposure to interest rates, foreign exchange, credit losses, airline conditions, economic conditions and geopolitical events.
- New revenue-recognition and lease-accounting standards were not yet effective; the company was evaluating their impact.
Important facts for investors to verify
- Progress and profitability of new commercial aviation programs and the timing of their second-half fiscal 2017 ramp-up.
- Revenue and margin attrition following the KC10 program transition.
- Cash conversion, working-capital requirements and the $47.9 million investment in long-term lease equipment.
- Revolving-facility availability, debt maturities, covenant compliance and future share repurchases or dividends.
- Potential financial, operational or contract impacts from the DynCorp litigation and the GASS contract transition.
- Comparability of reported net income and EPS given discontinued operations and the nonrecurring prior-year contingent-consideration gain.