AAR CORP. Fiscal 2016 Form 10-K Summary
Business context and reporting period
AAR CORP. is a diversified provider of aviation aftermarket products and services and government, defense and expeditionary services. The filing is the annual report for the fiscal year ended May 31, 2016, not a fiscal 2015 fourth-quarter filing. Operations are reported through Aviation Services and Expeditionary Services.
- Aviation Services represented 86% of fiscal 2016 sales and includes aviation supply-chain, parts distribution, MRO, engineering and landing-gear services.
- Expeditionary Services represented 14% of sales and includes expeditionary airlift, search and rescue, mobility products, shelters, pallets and systems integration.
- Backlog increased to approximately $953.9 million from $920.3 million; approximately $506.7 million was expected to be filled within 12 months.
Financial performance and position
| Metric | Fiscal 2016 | Fiscal 2015 | Change |
|---|---|---|---|
| Sales | $1,662.6 million | $1,594.3 million | Up 4.3% |
| Gross profit | $236.9 million | $159.3 million | Up 48.7% |
| Gross margin | 14.2% | 10.0% | Up approximately 420 basis points |
| Operating income | $65.8 million | $(11.9) million | Improved $77.7 million |
| Operating margin | 4.0% | (0.7)% | Improved |
| Income from continuing operations | $40.5 million | $(54.5) million | Returned to profitability |
| Net income attributable to AAR | $47.7 million | $10.2 million | Up $37.5 million |
| Diluted EPS | $1.37 | $0.24 | Up $1.13 |
| Operating cash flow, continuing operations | $30.4 million | $68.6 million | Down $38.2 million |
Fiscal 2016 Aviation Services sales increased 8.3% to $1,425.0 million, while segment gross profit increased 59.8% to $229.8 million. Expeditionary Services sales declined 14.6% to $237.6 million and gross profit declined 54.2% to $7.1 million.
- Cash and cash equivalents were $31.2 million, compared with $54.7 million at May 31, 2015.
- Working capital was $544.1 million, compared with $483.8 million.
- Total debt was $150.1 million, compared with $154.0 million; equity was $865.8 million.
- Revolving Credit Facility availability was approximately $377.7 million after $110.0 million of borrowings and $12.3 million of letters of credit. Including cash, management reported liquidity of approximately $409 million.
- Capital expenditures increased to $88.4 million from $42.1 million, principally due to expeditionary airlift investments.
- Dividends were $0.30 per share. Fiscal 2016 treasury-stock purchases totaled $18.8 million, and $82.7 million remained available under the repurchase authorization at year-end.
Material changes versus the prior comparable period
- Aviation Services growth was driven by higher distribution and MRO volumes, including increased government and defense sales. Commercial Aviation Services gross margin increased to 15.7% from 9.5%; government and defense gross margin increased to 17.2% from 15.2%.
- Expeditionary Services was pressured by reduced Department of Defense purchases of mobility products and continuing reductions in Afghanistan-related activity.
- Fiscal 2015 included $71.4 million of impairment charges and other losses on underperforming product lines, inventories, aircraft and equipment. These charges did not recur in fiscal 2016.
- Fiscal 2015 included a $44.9 million loss on extinguishment of debt. The redemption of the $325 million 7.25% Senior Notes substantially reduced interest expense, which fell to $6.4 million from $26.5 million.
- Fiscal 2015 included the $198.6 million pretax gain on the Telair Cargo Group sale. Fiscal 2016 included a $27.7 million pretax gain from contingent consideration related to that sale.
- Fiscal 2016 cash flow from continuing operations weakened because of lower accrued liabilities and tax payments and increased inventory and receivables associated with Aviation Services growth.
- The Company completed the start-up of a U.K. Ministry of Defense search-and-rescue contract in the Falkland Islands and closed its Hot Springs, Arkansas regional maintenance facility.
Guidance, outlook, risks and unusual items
Management projected fiscal 2017 consolidated sales of $1.7 billion to $1.8 billion and diluted EPS from continuing operations of $1.30 to $1.40. Management expected continued strength in Aviation Services but acknowledged pressure on defense budgets and ongoing uncertainty in Expeditionary Services.
- The KC-10 logistics support contract was awarded to a competitor in June 2016. AAR filed a protest and expected to continue providing services through late fiscal 2017. Historical average annual KC-10 revenue and gross profit were approximately $115.9 million and $7.4 million, respectively.
- U.S. government and defense sales were $642.6 million, or 38.7% of consolidated sales; sales to the U.S. government and its contractors were $513.8 million, or 30.9%. Funding, appropriations, competitive bidding, contract termination and sequestration remain material risks.
- Expeditionary airlift revenue remains exposed to further troop reductions, contract nonrenewals, termination, redeployment costs and difficulty selling or re-leasing aircraft.
- Precision Systems Manufacturing remained classified as discontinued operations and was still being marketed; management expected a sale before the end of fiscal 2017. The business had incurred $57.5 million of impairment charges in fiscal 2015.
- DynCorp appealed dismissal of litigation alleging trade-secret misappropriation involving a Department of State aviation-support solicitation. The Department of State OIG was investigating related allegations, and the contract had not yet been awarded.
- Other principal risks include commercial aviation cyclicality, customer credit and bankruptcy risk, fixed-price contract cost overruns, competition, FAA and other regulatory compliance, cybersecurity, international operations, environmental liabilities, skilled-labor shortages and asset impairment.
- Fiscal 2016 included early adoption of accounting standards affecting debt issuance costs and deferred-tax classification. The Company was evaluating the future effects of new revenue-recognition and lease-accounting standards.
Important facts for investors to verify
- Whether Aviation Services growth and margins offset the continuing decline in Expeditionary Services and Afghanistan-related revenue.
- The outcome and financial impact of the KC-10 contract protest and the timing of transition to the competitor.
- Conversion of the $953.9 million backlog into revenue, particularly the $506.7 million expected within 12 months.
- Operating cash-flow recovery after the fiscal 2016 decline and the sustainability of increased capital expenditures.
- Liquidity after fiscal 2017 debt maturities, purchase obligations of $227.5 million, lease commitments of $148.5 million and expected pension contributions of $7.3 million.
- Completion and proceeds from the planned Precision Systems Manufacturing divestiture and any remaining discontinued-operation liabilities.
- Exposure to U.S. government funding, contract renewals, fixed-price performance, regulatory investigations and the DynCorp litigation.