AAR CORP. Form 10-Q Summary
Reporting period: Quarter and nine months ended February 29, 2016; comparable periods ended February 28, 2015. This is fiscal 2016 third quarter, although the request metadata identifies “2015 Q3.” The filing is unaudited.
Business Context
AAR operates through two segments: Aviation Services, comprising supply chain and maintenance, repair and overhaul activities, and Expeditionary Services, comprising airlift and mobility products and services. The company continued its strategic transformation following the sale of the Telair Cargo Group and the planned sale of its Precision Systems Manufacturing businesses, both reported as discontinued operations.
Key Financial Metrics
| Metric | Three Months Ended Feb. 29, 2016 | Three Months Ended Feb. 28, 2015 | Nine Months Ended Feb. 29, 2016 | Nine Months Ended Feb. 28, 2015 |
|---|---|---|---|---|
| Sales | $402.8 million | $380.1 million | $1,204.4 million | $1,178.5 million |
| Operating income | $15.7 million | $9.0 million | $47.8 million | $61.2 million |
| Income from continuing operations attributable to AAR | $10.7 million | $1.9 million | $29.3 million | $27.6 million |
| Net income attributable to AAR | $4.8 million | $(34.5) million | $35.7 million | $(4.9) million |
| Diluted EPS | $0.14 | $(0.89) | $1.03 | $(0.15) |
Margins: Consolidated operating margin was approximately 3.9% in the quarter and 4.0% for the nine-month period, compared with approximately 2.4% and 5.2%, respectively, in the prior-year periods. Segment gross profit was $58.3 million in the quarter and $172.7 million year to date, versus $50.1 million and $179.7 million, respectively.
- Aviation Services: Quarterly sales increased 9.7% to $349.2 million and gross profit increased 15.6% to $58.6 million. Nine-month sales increased 7.2% to $1,024.6 million and gross profit increased 9.1% to $166.7 million.
- Expeditionary Services: Quarterly sales declined 13.1% to $53.6 million and the segment recorded a $0.3 million gross loss. Nine-month sales declined 19.2% to $179.8 million and gross profit declined 77.7% to $6.0 million.
- Cash flow: Operating activities used $13.9 million for the nine months, including a $14.1 million use from continuing operations, compared with $9.0 million provided in the prior-year period. Capital expenditures were $74.2 million, partly offset by $38.5 million of sale-leaseback proceeds.
- Liquidity: Cash was $50.4 million at February 29, 2016, compared with $54.7 million at May 31, 2015. Working capital was $611.0 million. The $500 million revolving credit facility had $135.0 million drawn and approximately $12.6 million of letters of credit, leaving approximately $352.4 million available; an additional $2.7 million was available under a foreign credit line.
- Debt: Total debt was $195.7 million, compared with $154.0 million at May 31, 2015. Current maturities were $35.7 million and long-term debt was $160.0 million. The company stated that it was in compliance with all financing covenants.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven by Aviation Services, particularly defense programs and distribution, while commercial aftermarket parts trading remained weaker.
- Expeditionary Services declined because of lower Department of Defense purchases of mobility products and fewer aircraft positions in Afghanistan following troop reductions.
- Interest expense fell by $4.7 million in the quarter and $14.2 million year to date, primarily following the fiscal 2015 redemption of $325 million of 7.25% senior notes.
- Quarterly net income improved from a $34.5 million loss to $4.8 million of income. The prior-year quarter included a $46.4 million discontinued-operations impairment charge.
- Year-to-date results included a $27.7 million gain from contingent consideration related to the Telair sale. Discontinued operations generated income of $6.4 million year to date versus a $32.3 million loss in the prior-year period.
- Inventory increased to $458.1 million from $456.0 million at May 31, 2015, primarily reflecting investment supporting new Aviation Services distribution contracts. Operating cash flow was adversely affected by inventory and other working-capital needs.
- The company repurchased $17.4 million of treasury stock during the first nine months, including 312,397 shares during the quarter at an average price of $23.44. Approximately $84.1 million remained available under the repurchase authorization at February 29, 2016.
Outlook, Risks, Contingencies and Unusual Items
- Management expected continued softness in Expeditionary Services because of weak demand and pricing pressure in the competitive Department of Defense market.
- The remaining $25.7 million carrying value of convertible notes due March 1, 2016 was retired at maturity for $26.0 million, including accrued interest.
- The company recognized a $2.5 million continuing-operations tax benefit from correcting prior-year immaterial errors, while recording tax expense in discontinued operations related to tax-return differences and deferred tax asset valuation allowances.
- AAR Airlift prevailed on a motion to dismiss DynCorp’s amended trade-secret complaint, but DynCorp appealed to the Eleventh Circuit. The State Department Office of Inspector General was also investigating substantially similar allegations; AAR stated that it was cooperating.
- Key disclosed risks include defense spending and contract demand, airline and aviation-market conditions, pricing pressure, working-capital requirements, interest rates, foreign exchange, credit losses, financing availability, litigation and government investigations.
- Management stated that disclosure controls were effective as of February 29, 2016 and that there were no material changes to internal control over financial reporting.
Investor Verification Points
- Verify the sustainability and margin profile of Aviation Services growth, particularly defense programs and new distribution contracts.
- Assess the duration and financial impact of weakness in Expeditionary Services, including reduced Afghanistan aircraft positions and lower mobility-product demand.
- Reconcile negative operating cash flow with reported earnings and monitor inventory, unbilled receivables and other working-capital investments.
- Confirm post-quarter debt repayment, revolving-credit availability and compliance with financial covenants.
- Follow the DynCorp appeal and the related Office of Inspector General investigation for potential contract, legal or reputational consequences.
- Separate recurring operating performance from discontinued-operations gains, tax adjustments and prior-year impairment comparisons.