AAR CORP. Form 10-Q Summary
Business Context and Reporting Period
AAR CORP. filed this unaudited Form 10-Q for the quarter ended August 31, 2010, the first quarter of fiscal 2011. The company operates through Aviation Supply Chain, Government and Defense Services, Maintenance, Repair and Overhaul, and Structures and Systems segments. The period includes revenue from Aviation Worldwide Services, acquired on April 7, 2010.
Financial Performance and Position
| Metric | Q1 FY2011 | Q1 FY2010 | Change |
|---|---|---|---|
| Sales | $412.2 million | $341.5 million | 20.7% increase |
| Operating income | $28.2 million | $17.2 million | 63.9% increase |
| Operating margin | 6.8% | 5.0% | Improved |
| Net income attributable to AAR | $13.7 million | $10.2 million | 34.0% increase |
| Diluted EPS | $0.35 | $0.27 | Increase |
| Operating cash flow | $7.2 million | $34.1 million | Decline |
| Capital expenditures | $37.0 million | $8.9 million | Increase |
Consolidated gross margin improved to 17.2% from 15.8%. Gross profit was $70.9 million versus $54.0 million. Net margin was approximately 3.3%, compared with approximately 3.0% in the prior-year quarter. The effective tax rate increased to 35.0% from 23.0%.
Cash and cash equivalents were $52.2 million at August 31, 2010, down from $79.4 million at May 31, 2010. Working capital was $523.0 million. The company had $60.0 million outstanding under its $250.0 million unsecured revolving credit facility, with approximately $9.6 million of letters of credit reducing availability, and $3.247 million available under a foreign line of credit. The revolving facility expires August 31, 2011.
Total recourse debt was $366.5 million and total non-recourse debt was $12.4 million at August 31, 2010. Current maturities included $53.3 million of recourse debt. Total assets were $1.53 billion and total equity was $759.7 million.
Material Changes Versus the Prior Comparable Period
- Government and Defense Services sales increased 252.0% to $129.3 million, primarily due to $65.3 million of Aviation Worldwide Services revenue and growth in a defense logistics program.
- Government and defense customers represented 55.4% of consolidated sales, and sales to those customers increased 44.7%.
- Aviation Supply Chain sales decreased 2.3%, but gross margin improved to 18.6% from 14.4%, partly because the prior-year period included a loss-making leveraged-lease interest sale.
- Maintenance, Repair and Overhaul sales declined 3.0%, reflecting fewer maintenance events by airline customers.
- Structures and Systems sales declined 14.7% because of lower mobility-products volume; gross margin nevertheless increased to 18.0% from 17.2%.
- Operating expenses increased 15.8%, mainly from the Aviation Worldwide Services acquisition.
- Operating cash flow declined substantially as inventory and rotable-spares investments increased to support growth initiatives.
- The company retired $6.0 million of 2.25% convertible notes for $4.7 million in cash and recognized a $97,000 gain on extinguishment of debt.
- The company repurchased 150,000 shares under its authorization for approximately $2.5 million; 1,028,300 shares remained available for repurchase.
Outlook, Risks, Contingencies, and Unusual Items
Management stated that airlines continued to add capacity and restore inventory provisioning slowly following earlier industry and economic weakness. Continued airline cost reductions, lower fleet utilization, customer liquidity constraints, and reduced demand for certain aircraft parts and maintenance services could adversely affect results.
Management believes the company is positioned to benefit from longer-term U.S. military deployment and program-management strategies, but stated that long-term government and defense demand remains difficult to predict. No specific earnings or revenue guidance was provided in the filing.
- Margins in the defense logistics business were pressured by transition costs for a new performance-based logistics program and a contract pricing adjustment.
- A former lessee of two wholly owned aircraft was in arrears. A judgment had been obtained against the lessee and affiliated guarantor, and management expected to recover past-due rentals. The net investments in the two aircraft were $7.4 million and $5.2 million.
- The company had approximately $54.8 million of capitalized, net A400M cargo-system development costs. Recoverability depends on projected program revenue and manufacturing costs.
- Goodwill impairment testing was not performed as of August 31, 2010 because management concluded it was unnecessary, but market conditions and the company’s share price would continue to be monitored.
- Aircraft, inventory, revenue-recognition, program-development, pension, and customer-credit estimates could produce materially different future results.
- The filing reported no material changes to previously disclosed risk factors or market risks. Management concluded that disclosure controls and procedures were effective as of August 31, 2010.
Investor Verification Checklist
- Verify the sustainability and margins of the government and defense revenue increase, including the contribution and integration of Aviation Worldwide Services.
- Review operating cash conversion, inventory growth, rotable-spares investments, and the elevated capital-expenditure program.
- Assess debt maturities, particularly the $53.3 million of current recourse maturities and the August 31, 2011 revolving-credit-facility expiration.
- Monitor airline capacity, customer credit quality, aircraft lease recoveries, and potential aircraft or inventory impairment.
- Evaluate the recoverability of the A400M development costs and the assumptions supporting long-term program revenue.
- Confirm future effects of defense-contract transition costs, pricing adjustments, taxes, and convertible-debt accounting on earnings and diluted share count.