AAR CORP. Form 10-Q Summary
Reporting period: Quarter and six months ended November 30, 2010, representing fiscal 2011 second-quarter and year-to-date results. The interim financial statements are unaudited and should be read with the fiscal 2010 Form 10-K.
Business Context
AAR operates through four segments: Aviation Supply Chain; Government and Defense Services; Maintenance, Repair and Overhaul; and Structures and Systems. The company serves commercial aviation, government and defense customers, and aerospace and defense manufacturers. The filing states that commercial aviation conditions improved during the period, while government and defense growth was significantly enhanced by the April 7, 2010 acquisition of Aviation Worldwide Services (“Airlift”).
Financial Metrics
| Metric | Three months ended Nov. 30, 2010 | Three months ended Nov. 30, 2009 | Six months ended Nov. 30, 2010 | Six months ended Nov. 30, 2009 |
|---|---|---|---|---|
| Sales | $447.1 million | $328.7 million | $859.3 million | $670.2 million |
| Operating income | $33.4 million | $26.3 million | $61.6 million | $43.5 million |
| Operating margin | 7.5% | 8.0% | 7.2% | 6.5% |
| Net income attributable to AAR | $16.8 million | $13.3 million | $30.5 million | $23.5 million |
| Net margin | 3.8% | 4.0% | 3.5% | 3.5% |
| Diluted EPS | $0.42 | $0.34 | $0.77 | $0.61 |
Cash flow: Six-month operating cash flow was $29.8 million, down from $58.1 million. Investing activities used $61.1 million, including $59.9 million of capital expenditures, primarily helicopters and other equipment supporting Government and Defense Services. Financing activities provided $1.2 million. Cash declined to $49.3 million from $79.4 million at May 31, 2010.
Liquidity and debt: Working capital was $530.0 million. The unsecured revolving credit facility provided borrowing capacity of up to $250.0 million, with $60.0 million borrowed and approximately $10.4 million of letters of credit outstanding at November 30, 2010. Approximate remaining availability was therefore $179.6 million, excluding any potential increase of up to $75.0 million. An additional $3.2 million was available under a foreign credit line. The facility matured August 31, 2011. Recourse debt totaled $366.7 million, non-recourse debt totaled $12.2 million, and capital lease obligations totaled $7.6 million, excluding the separately reported $60.0 million of short-term debt.
Balance sheet: Total assets were $1.56 billion and total equity was $780.9 million at November 30, 2010. Inventories increased to $387.2 million from $370.3 million at May 31, 2010, while accounts receivable increased to $257.4 million from $238.5 million.
Material Changes Versus Prior Comparable Period
- Second-quarter sales increased 36.0%; six-month sales increased 28.2%.
- Government and Defense Services sales increased 241.7% in the quarter and 246.7% year to date, primarily due to Airlift and the ramp-up of a new performance-based logistics program.
- Commercial customer sales increased 26.9% in the quarter and 13.1% year to date.
- Maintenance, Repair and Overhaul sales increased 37.9% in the quarter and 16.4% year to date.
- Structures and Systems sales declined 17.0% in the quarter and 15.9% year to date, reflecting lower mobility-products volume.
- Second-quarter gross margins declined in Aviation Supply Chain, Government and Defense Services, and Structures and Systems due primarily to product mix, transition costs, contract pricing adjustments, and lower volume. MRO margin improved to 12.4% from 11.9%.
- Net interest expense increased 21.5% in the quarter and 19.0% year to date, primarily because of higher borrowings.
- The company retired $6.0 million of convertible-note principal for $4.7 million of cash, producing a $97,000 gain on extinguishment of debt.
Outlook, Commentary, Risks and Unusual Items
Management described improving airline revenues, profitability, fleet capacity, and utilization, and expects carriers to continue outsourcing maintenance and support functions. Management also is targeting additional U.S. government agencies for Airlift services beyond the Department of Defense.
Subsequent to quarter-end, AAR decided to exit its Amsterdam component repair facility and was evaluating strategic alternatives, including a sale. The facility generated $14.3 million of sales and a $2.6 million pretax loss during the six months ended November 30, 2010. AAR expected to recover its approximately $11.0 million carrying value and expected to report the unit as discontinued operations beginning in the third quarter of fiscal 2011.
Key exposures include commercial aviation demand, government funding and contract performance, credit-market access, customer creditworthiness, inventory and aircraft valuation, goodwill impairment, revenue and program estimates, pension assumptions, and recovery of approximately $59.0 million of capitalized A400M program-development costs. A former lessee of two wholly owned aircraft was in arrears; AAR had obtained a judgment and expected to recover past-due rentals.
Management reported no material changes to market risks or previously disclosed risk factors. Disclosure controls and procedures were considered effective as of November 30, 2010, with no material changes to internal control over financial reporting.
Facts Investors Should Verify
- Whether the Airlift acquisition and defense logistics program can sustain growth without further margin pressure or transition costs.
- The maturity and refinancing status of the credit facility, including the $60.0 million drawn balance and letters of credit.
- Progress and financial impact of exiting or selling the Amsterdam facility and the timing of discontinued-operations reporting.
- Inventory, aircraft, goodwill, and A400M program-development-cost valuations, including potential impairment or recovery risks.
- Whether operating cash flow improves as inventory, receivables, and leased-equipment investments normalize.
- The effect of Structures and Systems volume declines and Aviation Supply Chain product mix on consolidated margins.