AAR CORP. Form 10-Q Summary
Reporting period: Quarter and nine months ended February 28, 2014. The filing is unaudited and covers AAR CORP. and subsidiaries. AAR operates through Aviation Services and Technology Products.
Financial Performance and Position
| Metric | Three months ended Feb. 28, 2014 | Prior year | Nine months ended Feb. 28, 2014 | Prior year |
|---|---|---|---|---|
| Sales | $474.4 million | $520.2 million | $1,529.6 million | $1,583.5 million |
| Gross profit | $78.7 million | $76.2 million | $254.4 million | $253.9 million |
| Gross margin | 16.6% | 14.6% | 16.6% | 16.0% |
| Operating income | $33.7 million | $37.6 million | $112.6 million | $113.8 million |
| Net income attributable to AAR | $17.9 million | $18.4 million | $55.8 million | $54.4 million |
| Diluted EPS | $0.45 | $0.46 | $1.40 | $1.35 |
- Segment results: Third-quarter Aviation Services sales declined 9.9% to $367.8 million, while gross profit increased 0.7% to $59.4 million. Technology Products sales declined 4.8% to $106.6 million, while gross profit increased 12.2% to $19.3 million.
- Cash flow: Operating cash flow for the first nine months was $76.7 million, compared with $87.8 million in the prior-year period. Investing activities used $36.5 million, including $21.2 million of capital expenditures and $16.1 million for the acquisition of cargo-system assets from PFW Aerospace in Germany. Financing activities used $2.0 million.
- Liquidity: Cash was $114.7 million at February 28, 2014, up from $75.3 million at May 31, 2013. Working capital was $736.3 million. The $475.0 million revolving credit facility had $140.0 million drawn and approximately $14.7 million of letters of credit, leaving approximately $320.3 million available, plus $5.4 million under foreign lines of credit.
- Debt: Total debt was $714.4 million, including $87.8 million of current maturities. Net outstanding borrowings were $599.7 million, down from $675.4 million at February 28, 2013. The 1.625% convertible notes were retired for $68.4 million on March 3, 2014. The company reported compliance with all financing covenants.
- Balance sheet: Total assets were $2.213 billion and total equity was $988.1 million at February 28, 2014. Inventories increased to $506.8 million from $453.7 million at May 31, 2013, primarily reflecting support for new inventory-management programs.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales decreased 8.8%, primarily because a significant engineering-services program ended in the second quarter, landing-gear overhaul timing was unfavorable, and Afghanistan airlift activity declined.
- Nine-month sales decreased 3.4%. Aviation Services sales declined modestly, while Technology Products sales fell 11.1%, driven mainly by lower defense demand for mobility products.
- Gross margins improved despite lower revenue. The prior-year period included a $9.1 million inventory-disposition loss; the current period was affected by lower facility volumes and start-up costs at the Lake Charles, Louisiana airframe-maintenance facility.
- Third-quarter operating income declined $3.9 million. SG&A increased $3.8 million as the prior-year period included a $9.0 million benefit from the final settlement of an acquisition earn-out. Excluding that benefit, current-period SG&A decreased $5.2 million.
- The effective tax rate declined to 22.7% in the third quarter from 33.5%, partly due to a $2.7 million reduction in tax expense related to federal income-tax-return filing differences. The nine-month effective tax rate was 31.1%, compared with 34.1%.
- Technology Products defense gross profit declined 42.5% for the nine-month period, reflecting lower sales of high-margin mobility products. Aviation Services defense gross profit increased 11.2%, supported by improved aircraft availability.
Guidance, Outlook, Risks and Unusual Items
- Management reduced fiscal 2014 revenue guidance to $2.000 billion-$2.050 billion from $2.100 billion-$2.150 billion and diluted EPS guidance to $1.79-$1.82 from $1.95-$2.00.
- Afghanistan troop withdrawals and reduced U.S. military activity are expected to pressure expeditionary airlift operations. AAR expected 20 of 40 aircraft in revenue service at the beginning of fiscal 2014 to be de-scoped by year-end, with three additional positions expected, resulting in 23 positions.
- Two Afghanistan airlift contracts were renewed through May 31, 2014 and October 31, 2014, respectively, with one option year remaining on each. A new $23 million Africa Command contract was under protest, and a separate Afghan National Security Forces IDIQ contract had a maximum value of $134 million but was awaiting task orders.
- The A400M cargo-system program is expected to generate approximately $250 million of revenue through fiscal 2020 based on current projections. Capitalized program-development costs totaled $133.7 million, creating exposure to cost, production and recoverability estimates.
- The filing identifies interest-rate and foreign-currency risks. A hypothetical 10% U.S. dollar devaluation against foreign currencies would have reduced nine-month pre-tax income by approximately $1.4 million. Interest-rate exposure is partly hedged through a swap and cap covering $50.0 million each of revolving-credit notional principal.
- Accounts receivable included $19.6 million of unbilled amounts related to the KC-10 supply agreement, and other non-current assets included $10.8 million of costs in excess of billings under the same program.
- Management stated that there were no material changes to previously disclosed risk factors, no significant changes in critical accounting policies, and no material changes to internal control over financial reporting.
Important Facts for Investors to Verify
- Confirm the post-quarter-end retirement of the $68.4 million convertible notes and its effect on liquidity, debt maturities and interest expense.
- Assess whether reduced Afghanistan activity, aircraft de-scoping and contract protests affect the revised fiscal 2014 guidance.
- Monitor inventory growth, KC-10 unbilled receivables and excess costs over billings for collection and recoverability risk.
- Evaluate the recoverability of $133.7 million in capitalized A400M program-development costs against actual deliveries, costs and customer demand.
- Verify whether Technology Products defense demand and Aviation Services commercial volumes stabilize sufficiently to support the company’s margin and EPS outlook.
- Review debt covenants, variable-rate exposure and available revolver capacity in light of the company’s debt maturities and ongoing capital needs.