AAR CORP. Form 10-Q Summary
Reporting period: Three months ended August 31, 2013, representing the first quarter of fiscal 2014. Financial statements are unaudited and prepared under U.S. GAAP. The company operates through Aviation Services and Technology Products.
Key Financial Metrics
| Metric | Q1 FY2014 | Q1 FY2013 | Change |
|---|---|---|---|
| Sales | $514.5 million | $550.5 million | Down 6.5% |
| Operating income | $38.2 million | $38.4 million | Down $0.2 million |
| Income before taxes | $27.5 million | $28.0 million | Down $0.5 million |
| Net income attributable to AAR | $17.9 million | $18.2 million | Down $0.3 million |
| Diluted EPS | $0.45 | $0.45 | Flat |
| Operating cash flow | $27.5 million | $33.2 million | Down $5.7 million |
Consolidated gross profit was $84.7 million, compared with $90.3 million, implying a gross margin of approximately 16.5% versus 16.4% in the prior-year quarter. Operating margin was approximately 7.4% versus 7.0%; net margin was approximately 3.5% versus 3.3%. The effective income tax rate was 34.5% in both periods.
- Aviation Services: Sales declined 1.1% to $393.7 million, while gross profit increased 6.7% to $65.5 million. Gross margin improved to 16.6% from 15.4%, primarily because of improved margins in the airlift business.
- Technology Products: Sales declined 20.7% to $120.8 million and gross profit declined 33.6% to $19.2 million. Gross margin fell to 15.9% from 19.0%, reflecting lower sales of higher-margin mobility products.
- Cash and working capital: Cash was $90.9 million at August 31, 2013, up from $75.3 million at May 31, 2013. Working capital was $687.6 million.
- Debt: Total debt was $702.2 million, including $86.8 million of current maturities and $615.4 million of long-term debt. Estimated fair value was approximately $717.8 million.
- Revolving facility: The company had $120.0 million drawn under its $475.0 million unsecured revolving credit facility and approximately $15.1 million of outstanding letters of credit, leaving approximately $339.9 million available. Foreign credit lines provided an additional $5.3 million of availability.
- Cash flows: Investing activities used $7.3 million, primarily for capital expenditures. Financing activities used $4.7 million, primarily for debt reduction and dividends. The company paid $3.0 million in cash dividends.
Material Changes Versus the Prior Comparable Period
- Sales to commercial customers decreased 6.1%, primarily because certain customers deferred engine maintenance visits. Management expected commercial sales to return to growth in the second quarter.
- Sales to global government and defense customers decreased approximately 7.1% to 7.2%, reflecting lower demand for mobility products, partially offset by increased airlift sales.
- Technology Products sales were $31.5 million lower, including a $37.4 million decline in mobility-products sales. Management expected mobility-products sales to remain steady and be neutral to the prior year for the balance of fiscal 2014.
- SG&A expense declined $5.6 million, primarily due to lower incentive compensation and lower intangible-asset amortization, substantially offsetting the reduction in gross profit.
- Net interest expense increased $0.5 million, partly because of higher borrowing costs following the April 2013 issuance of 7.25% notes.
- Cash from operations declined from $33.2 million to $27.5 million, principally because of lower cash benefits from working-capital changes, including a decrease in accrued liabilities.
Outlook, Risks, Contingencies, and Unusual Items
- The airlift business generated most of its revenue from supplemental airlift services in Afghanistan for the U.S. Department of Defense. Planned reductions in U.S. military activity and troop withdrawals in 2014 create contract-renewal and demand risk.
- Airlift contracts with option renewals in October 2013 and May 2014 had aggregate annual sales value of approximately $220 million. A contract expiring November 30, 2013 had annual sales value of approximately $110 million. The customer preliminarily indicated an intent to exercise the October 2013 option, but the filing states that the November contract had several possible outcomes.
- The company planned to retire the $68.4 million principal amount of 1.625% convertible notes due March 1, 2014 using cash on hand and the revolving credit facility.
- The company had $22.6 million of unbilled receivables and $11.2 million of costs in excess of amounts billed related to the KC-10 supply agreement. Recovery depends on future billings and additional cost savings.
- AAR had capitalized approximately $126.9 million of net A400M cargo-system development costs. The company expected approximately $250 million of related revenue through fiscal 2020 based on current projections, but warned that differences between estimated and actual costs or revenue could impair recoverability.
- The company granted 1,026,515 stock options in July 2013 at an exercise price of $25.43 and granted performance-based and time-based restricted stock.
- Interest-rate derivatives hedged $50.0 million each of revolving-credit-facility exposure through an interest-rate swap and cap. A hypothetical 10% devaluation of the U.S. dollar against foreign currencies would have reduced quarterly pretax income by approximately $1 million.
- The company reported compliance with all financial covenants as of August 31, 2013. Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting or material changes to previously disclosed risk factors.
Investor Verification Checklist
- Verify the renewal, extension, or replacement outcome of the November 30, 2013 airlift contract and the impact of Afghanistan drawdown plans on airlift revenue and margins.
- Monitor commercial aftermarket demand and whether deferred engine maintenance visits resume as expected in the second quarter.
- Assess whether Technology Products and mobility-product sales stabilize as management projected.
- Confirm the funding and refinancing of the $68.4 million convertible-note maturity due March 1, 2014.
- Review the collectability of KC-10 unbilled receivables and recovery of costs in excess of amounts billed.
- Evaluate the recoverability of A400M capitalized development costs against actual production volumes, pricing, and manufacturing costs.
- Track debt levels, interest expense, covenant compliance, and availability under the revolving credit facility.