AAR CORP. 10-Q Summary
Business context and reporting period
AAR CORP. filed an unaudited Form 10-Q for the three months ended August 31, 2011, the first quarter of fiscal 2012. The company operates through Aviation Supply Chain, Government and Defense Services, Maintenance, Repair and Overhaul, and Structures and Systems. Commercial customers represented 51.8% of sales, while government and defense customers represented 48.2%.
Financial performance and position
| Metric | Q1 FY2012 | Q1 FY2011 | Change |
|---|---|---|---|
| Sales | $479.3 million | $404.4 million | 18.5% |
| Operating income | $33.3 million | $28.8 million | 15.7% |
| Income from continuing operations | $17.0 million | $14.0 million | 20.8% |
| Net income | $16.6 million | $13.7 million | 21.8% |
| Diluted EPS | $0.41 | $0.35 | 17.1% |
| Cash flow from operations | $(25.6) million | $7.2 million | Use of cash increased |
| Capital expenditures | $41.8 million | $37.0 million | 12.7% |
Gross profit was $74.8 million versus $70.0 million. Consolidated gross margin declined to approximately 15.6% from 17.3%, while operating margin was approximately 6.9% versus 7.1% and net margin was approximately 3.5% versus 3.4%. The effective income tax rate was 34.5%, compared with 35.0%.
Segment sales were $154.9 million for Aviation Supply Chain, $150.0 million for Government and Defense Services, $93.2 million for Maintenance, Repair and Overhaul, and $81.2 million for Structures and Systems. Segment gross margins were approximately 16.3%, 18.3%, 11.0%, and 14.6%, respectively.
At August 31, 2011, cash and cash equivalents were $35.5 million, working capital was $594.2 million, and total assets were $1.75 billion. Recourse debt was $483.9 million, including $150.0 million drawn under the unsecured revolving credit facility and $52.6 million under a secured revolving facility. The unsecured facility had $11.4 million of outstanding letters of credit reducing availability; the filing also reported $3.6 million available under a foreign line of credit.
Material changes versus the prior comparable period
- Sales increased 18.5%, primarily from commercial aviation recovery, stronger parts and MRO demand, new programs, and the sale of two aircraft for approximately $33.3 million.
- Commercial sales increased 40.2%; government and defense sales increased 1.6%.
- Aviation Supply Chain sales increased 54.5%, but its gross margin declined because of the aircraft sales mix.
- Government and Defense Services sales increased 16.0%, with improved gross margin.
- Maintenance, Repair and Overhaul sales increased 21.3%, but margin declined because of unfavorable mix.
- Structures and Systems sales declined 17.1%, and gross margin declined because of lower mobility-products volume and product mix.
- Operating income increased despite lower consolidated gross margins. Interest expense increased modestly due primarily to higher borrowings.
- Operating cash flow shifted from $7.2 million provided in the prior-year quarter to $25.6 million used, principally because of inventory, rotables, lease equipment, program costs, and a license-fee payment.
- The company entered into a ten-year exclusive distribution agreement with Unison Industries, expected to generate approximately $600 million of revenue over its term. A $7.0 million initial payment was made, with additional annual payments through 2021.
- A non-recourse note became fully recourse to the company during the quarter, increasing reported recourse debt.
Outlook, risks, contingencies, and unusual items
Management reported improving commercial aviation demand, including fleet expansion, inventory replenishment, new programs, and share gains. No quantitative earnings or revenue guidance was provided. Management stated that airlift services may have additional opportunities with U.S. government agencies beyond the Department of Defense.
Cash usage and liquidity are key considerations because working-capital investments and capital expenditures exceeded internally generated cash during the quarter. The company expects to continue investing in growth, including helicopters and other equipment supporting Government and Defense Services and the A400M program.
- The company capitalized $77.8 million of net A400M program development costs. Recovery depends on future program revenue and manufacturing costs; adverse changes could result in impairment.
- Inventory and aircraft valuation depend on demand, lease rates, residual values, market conditions, and other estimates. A $5.4 million pre-tax aircraft impairment was recorded in the fourth quarter of fiscal 2011.
- The company exited its Amsterdam component repair facility, classified as a discontinued operation. The unit had approximately $7.6 million of carrying value, and management expected to recover it. The discontinued operation generated a $0.3 million after-tax loss in the quarter.
- Interest-rate exposure is partly hedged through a $50.0 million floating-to-fixed swap and a $50.0 million interest-rate cap. The swap had a $2.9 million liability fair value and the cap had a $0.8 million asset fair value at quarter-end; the effective hedge loss recorded in other comprehensive income was $2.5 million.
- Forward-looking results remain subject to airline industry conditions, government and defense spending, economic and credit-market conditions, geopolitical events, customer demand, execution, and management estimates.
- Management reported no material changes to the risk factors disclosed in the fiscal 2011 Form 10-K. Disclosure controls and procedures were assessed as effective.
Important facts for investors to verify
- Whether commercial aviation demand and the reported recovery continue after the benefit from the two aircraft sales.
- Whether inventory, rotables, lease equipment, and program investments convert into operating cash flow without material write-downs.
- Availability under the revolving credit facilities and compliance with fixed-charge, leverage, tangible-net-worth, and other debt covenants.
- The timing and economics of aircraft dispositions, lease renewals, and the expected recovery of the discontinued Amsterdam operation.
- The recoverability of the $77.8 million A400M capitalized development-cost balance.
- Whether lower margins in Aviation Supply Chain, MRO, and Structures and Systems reverse as product mix and volumes change.
- The effect of convertible debt, assumed conversion shares, stock compensation, and share repurchases on future diluted EPS.