AAR CORP. Form 10-K Summary
Reporting period: Fiscal year ended May 31, 2013. The request references 2012 Q4, but the supplied filing is the fiscal 2013 Form 10-K and includes fourth-quarter fiscal 2013 results. Dollars are in millions unless otherwise stated.
Business Context
AAR provides aviation aftermarket services and technology products to commercial aviation, government and defense customers worldwide. Its two reportable segments are Aviation Services, including parts distribution, supply-chain programs, repair and overhaul, aircraft leasing and expeditionary airlift, and Technology Products, including cargo systems, pallets, containers, shelters, machining and aerospace components.
- Fiscal 2013 segment reporting was changed from four segments to two, with prior periods recast.
- Firm backlog was approximately $973.0, compared with $928.7 at May 31, 2012; approximately $739.1 was expected to be fulfilled within 12 months.
- Government and defense sales were $839.2, or 39.3% of total sales, compared with $930.4, or 45.1%, in fiscal 2012.
- U.S. government and contractor sales were $763.2, or 35.7% of consolidated sales.
Financial Performance and Position
| Metric | Fiscal 2013 | Fiscal 2012 | Change |
|---|---|---|---|
| Sales | $2,137.3 | $2,065.0 | +3.5% |
| Gross profit | $314.2 | $318.6 | -1.4% |
| Gross margin | 14.7% | 15.4% | Down 70 bps |
| Operating income | $122.6 | $130.7 | -6.2% |
| Income before taxes | $82.2 | $93.5 | -12.1% |
| Net income attributable to AAR | $55.0 | $67.7 | -18.8% |
| Diluted EPS | $1.38 | $1.65 | -16.4% |
| Cash flow from operations | $162.9 | $94.2 | +$68.7 |
| Capital expenditures | $37.6 | $91.2 | -$53.6 |
| Cash and equivalents | $75.3 | $67.7 | +$7.6 |
| Working capital | $644.7 | $590.1 | +$54.6 |
| Total recourse debt | $708.6 | $792.2 | -$83.6 |
Aviation Services sales increased 5.1% to $1,614.4, while gross profit declined 4.1% to $227.5 and segment gross margin fell to 14.1% from 15.4%. Technology Products sales declined 1.2% to $522.9, while gross profit increased 6.6% to $86.7 and margin improved to 16.6% from 15.4%.
Fiscal 2013 cash flow from investing activities used $32.8, including $37.6 of capital expenditures and $21.3 of final acquisition payments. Financing activities used $123.7, primarily reflecting $274.3 of debt reduction, $14.6 of share repurchases and $12.8 of dividends.
At May 31, 2013, total assets were $2,136.9 and total equity was $919.5. Inventory was $453.7 and accounts receivable were $297.4.
Material Changes Versus Prior Period
- Commercial sales increased 14.4% and represented approximately 61% of consolidated sales, driven by organic Aviation Services growth and the full-year contribution from the Telair and Nordisk acquisitions.
- Government and defense sales decreased 9.8%, principally because of lower mobility-product volumes and reduced logistics-program activity, partially offset by higher expeditionary airlift sales.
- AAR recorded a $29.8 pretax fourth-quarter charge on the KC10 support contract after lower flight hours and revised cost-recovery expectations reduced projected revenue and profitability.
- The prior year included approximately $49.0 of wholly owned aircraft sales; no comparable wholly owned aircraft sales occurred in fiscal 2013.
- Selling, general and administrative expense increased 4.8% to $198.4, partly because of the acquired businesses.
- Interest expense increased to $41.6 from $37.7, primarily because of borrowings used to fund the fiscal 2012 acquisitions.
- The effective tax rate increased to 32.5% from 27.2%, reducing net income.
- AAR reduced its unsecured revolving facility commitment from $580.0 to $475.0 and extended maturity to April 24, 2018. It also issued $150.0 of 7.25% senior notes due 2022 and used the net proceeds to repay revolving debt.
Guidance, Outlook, Risks and Unusual Items
Management expected fiscal 2014 sales of approximately $2,175 to $2,225 and diluted EPS of $2.00 to $2.05. The outlook assumed continued strength in supply-chain and repair businesses, stable Technology Products revenue, efficiency improvements and demand for contractor-operated airlift services.
- The KC10 contract carried approximately $9.9 of costs in excess of billings at May 31, 2013. Management expected recovery through future billings and cost savings, but fiscal 2014 flight-hour revenue was expected to be approximately $45.0 at a 0% margin.
- Airlift revenue was concentrated in Afghanistan. Contracts with option renewals had aggregate annual sales value of approximately $220.0, and another contract expiring November 30, 2013 had annual sales value of approximately $110.0. Nonrenewal or drawdown of U.S. military operations could materially reduce revenue.
- The A400M program had $130.9 of capitalized development costs at May 31, 2013 and expected revenue of approximately $250.0 through fiscal 2020. Recovery depended on program delivery, cost reductions and continued customer demand.
- Key risks include defense-budget pressure and sequestration, commercial aviation cyclicality, customer credit and bankruptcy risk, fixed-price contract overruns, competition, regulatory compliance, international operations, aircraft and inventory impairment, financing and covenant requirements, cybersecurity, environmental liabilities and skilled-labor availability.
- Debt was subject to restrictive and financial covenants; management reported compliance at May 31, 2013. Letters of credit and performance bonds totaled approximately $17.8.
- No material pending legal proceeding other than routine litigation was reported. KPMG issued unqualified opinions on the financial statements and internal control over financial reporting.
Investor Verification Priorities
- Verify the sustainability of commercial sales growth and whether defense sales continue to decline.
- Reconcile the $29.8 KC10 charge with future billings, flight-hour assumptions, margin expectations and recovery of the $9.9 cost-over-billing balance.
- Assess Afghanistan airlift contract renewals, customer concentration and the effect of U.S. defense-budget reductions.
- Review A400M development-cost recovery, production-cost targets, delivery timing and contract amendments.
- Evaluate debt maturities, variable-rate exposure, covenant headroom and liquidity after scheduled obligations.
- Monitor gross-margin recovery, Technology Products demand and the effect of acquisitions on operating expenses.
- Assess potential impairment exposure for aircraft, inventory, goodwill and capitalized program-development costs.