AAR CORP. Form 10-Q Summary
Business context and reporting period
AAR CORP. filed an unaudited Form 10-Q for the quarter ended February 28, 2013, representing fiscal 2013 third-quarter results. The company reports two segments: Aviation Services and Technology Products. Prior periods were recast to conform to the new segment structure.
Financial results and key metrics
| Metric | Three months ended February 28, 2013 | Three months ended February 29, 2012 | Nine months ended February 28, 2013 | Nine months ended February 29, 2012 |
|---|---|---|---|---|
| Sales | $520.2 million | $534.2 million | $1,583.5 million | $1,501.7 million |
| Operating income | $37.6 million | $35.8 million | $113.8 million | $102.9 million |
| Net income attributable to AAR | $18.4 million | $20.6 million | $54.4 million | $54.8 million |
| Diluted EPS | $0.46 | $0.50 | $1.35 | $1.33 |
| Operating margin | 7.2% | 6.7% | 7.2% | 6.9% |
- Gross profit was $76.2 million in the quarter and $253.9 million for the nine-month period, compared with $86.9 million and $241.2 million, respectively, in the prior-year periods.
- Quarterly Aviation Services sales increased 9.3% to $408.2 million, while Technology Products sales declined 30.4% to $112.0 million. Nine-month sales increased 4.4% in Aviation Services and 8.7% in Technology Products.
- Quarterly Aviation Services gross margin decreased to 14.5% from 15.6%, primarily due to a $9.1 million inventory disposal loss. Technology Products gross margin decreased to 15.4% from 17.7%.
- Nine-month operating cash flow was $87.8 million, versus $18.2 million in the prior-year period.
- Nine-month investing cash use was $13.9 million, including $23.9 million of capital expenditures and a $16.5 million final payment related to the Telair and Nordisk acquisitions.
- Nine-month financing cash use was $95.5 million, primarily reflecting net debt reduction, dividends of $9.9 million, and treasury-stock purchases of $8.4 million.
- Cash declined to $47.4 million at February 28, 2013, from $67.7 million at May 31, 2012. Working capital was $713.3 million.
- Total debt was $722.8 million, compared with $792.2 million at May 31, 2012. Long-term debt was $700.6 million. The company reported compliance with all financial covenants.
Material changes versus the prior comparable period
- Quarterly sales declined 2.6%, but nine-month sales increased 5.4%, largely reflecting growth from the Telair and Nordisk acquisitions and organic growth in airframe maintenance, parts supply, and engineering services.
- Commercial sales increased 6.6% in the quarter and 18.9% for nine months; government and defense sales decreased 14.7% and 9.8%, respectively.
- Technology Products quarterly sales were pressured by completion of a large contract, reduced shelter and container demand, and lower defense spending. Nine-month results benefited from $114.3 million of non-comparative revenue from Telair and Nordisk.
- Quarterly net income declined despite higher operating income, primarily because the effective tax rate increased to approximately 33.5% from 18.8%. The prior-year quarter included a $4.0 million tax benefit from state tax planning.
- The company reduced debt through repayments and convertible-note repurchases. It also funded a $63.6 million purchase of 1.75% convertible notes due 2026 under holders’ put rights and exchanged $22.7 million principal amount of those notes for a new $30.0 million convertible note due February 2015.
- The company settled the Airinmar earn-out for $4.6 million, $9.0 million below the previously estimated liability; the reduction benefited quarterly selling, general and administrative expense.
- The company changed from four reported segments to Aviation Services and Technology Products and recast prior periods. Goodwill impairment testing indicated no impairment as of November 30, 2012.
Guidance, outlook, commentary, risks, and unusual items
- Airlift contracts supporting operations in Afghanistan had renewal options in May, October, and November 2013 with aggregate annual sales value of approximately $325 million. Management believed some or all options were likely to be exercised, but had not received official notification.
- The planned U.S. military drawdown from Afghanistan and defense-budget pressure, including sequestration effective March 1, 2013, could reduce government-related revenue. The filing states that the effect of sequestration could not yet be estimated.
- The A400M cargo-loading-system program is subject to disputes with Airbus. AAR had capitalized $125.4 million of related development costs and was negotiating contract modifications that could reduce its role and expected revenue. Failure to reach agreement could result in arbitration and potential impairment or failure to recover some or all development costs.
- The company retained aircraft, program, inventory, foreign-currency, and interest-rate exposure. A hypothetical 10% devaluation of the U.S. dollar against foreign currencies was estimated to reduce earnings by approximately $1 million.
- Unbilled accounts receivable related to the KC-10 supply agreement were $31.4 million, and costs in excess of amounts billed were $35.8 million. Recovery depends on future customer billings over the program life.
- The company expected to repurchase the remaining $2.7 million of 2026 convertible notes during the fourth quarter of fiscal 2013.
- No formal quantitative earnings or revenue guidance was provided in the filing. Management stated that interim results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether the Afghanistan airlift contract options were exercised and the resulting effect on revenue and profitability.
- The financial impact of sequestration, defense-budget reductions, and declining mobility-products demand.
- The resolution of the A400M contract disputes, expected revenue, recoverability of the $125.4 million capitalized development balance, and any arbitration exposure.
- Progress on debt reduction, the remaining convertible-note repurchase, liquidity availability, and compliance with debt covenants.
- Whether the $9.1 million inventory disposal loss and Airinmar earn-out settlement were nonrecurring and how comparable margins develop thereafter.
- Collection and billing timing for the $31.4 million of unbilled KC-10 receivables and recovery of the $35.8 million cost-over-billings balance.
- The effects of the segment reorganization and the Telair and Nordisk acquisition on organic growth, margins, goodwill, and intangible assets.