AAR CORP. Form 10-Q Summary
Business context and reporting period
AAR CORP. provides aviation aftermarket services, supply-chain and logistics programs, aircraft maintenance and modification, expeditionary airlift, and aerospace and defense products. The filing covers the unaudited quarter ended August 31, 2014, the first quarter of fiscal 2015, compared with the quarter ended August 31, 2013.
Financial performance and position
| Metric | Q1 FY2015 | Q1 FY2014 | Change |
|---|---|---|---|
| Sales | $469.2 million | $514.5 million | Down 8.8% |
| Gross profit | $75.3 million | $84.7 million | Down 11.1% |
| Gross margin | 16.0% | 16.5% | Down approximately 50 bps |
| Operating income | $31.0 million | $38.2 million | Down 18.8% |
| Operating margin | 6.6% | 7.4% | Down approximately 80 bps |
| Net income attributable to AAR | $14.4 million | $17.9 million | Down 19.6% |
| Diluted EPS | $0.36 | $0.45 | Down $0.09 |
| Operating cash flow | $15.0 million | $27.5 million | Down $12.5 million |
Sales declined in both reportable segments: Aviation Services sales were $363.7 million, down 7.6%, and Technology Products sales were $105.5 million, down 12.7%. Segment gross profit was $59.1 million and $16.2 million, respectively. The effective tax rate improved to 32.6% from 34.5%, primarily due to expected manufacturing incentives and utilization of tax losses.
At August 31, 2014, cash and cash equivalents were $81.8 million, working capital was $739.6 million, and total assets were $2.21 billion. Total debt was $627.1 million, including $78.5 million of current maturities; long-term debt was $548.6 million. The company had $130.0 million outstanding under its $475.0 million unsecured revolving credit facility, approximately $14.8 million of letters of credit, and approximately $330.2 million of remaining availability. Management stated that all debt covenants were satisfied.
Investing activities used $10.1 million, principally for property, plant and equipment. Financing activities used $11.6 million, primarily for debt reduction and dividends. Cash decreased by $7.4 million during the quarter.
Material changes versus the prior comparable period
- Commercial customer sales increased $7.2 million, or 2.4%, while government and defense sales decreased $52.5 million, or 24.1%.
- Aviation Services commercial sales increased 7.0%, but defense sales fell 26.5%, primarily because of lower Afghanistan expeditionary airlift demand and the absence of a foreign defense aircraft delivery recorded in the prior-year quarter.
- Technology Products sales declined in both commercial and defense markets. Defense gross margin fell to 5.1% from 9.5%, partly due to lower mobility-product volumes and sales of the low-margin A400M system.
- Selling, general and administrative expense decreased $2.8 million due to cost-control measures, partially offsetting lower segment profit.
- Accounts receivable increased to $294.9 million from $283.1 million at May 31, 2014, and inventories increased to $532.0 million from $495.3 million.
- The company reduced its expeditionary fleet in revenue service from 40 aircraft at the beginning of fiscal 2014 to 19 aircraft at August 31, 2014, and had 15 aircraft held for sale versus nine at May 31, 2014.
Outlook, commentary, risks and unusual items
Management cited continued lower Afghanistan demand but identified new or renewed expeditionary airlift contracts supporting U.S. Africa Command, the U.S. Navy, and other customers. Reported contract awards included a $49 million Africa Command contract beginning December 1, 2014, a $34 million Navy contract beginning October 1, 2014, and a $34 million Africa Command contract beginning October 24, 2014. The company also had a $134 million maximum-value IDIQ contract for Afghan security forces, although task orders had not yet been received. The filing provides no quantitative consolidated earnings or revenue guidance.
- The company expects to fund debt maturities due within 12 months with cash on hand and revolver borrowings. It exercised its right to redeem the outstanding 1.75% convertible notes due February 2015 at a premium, with redemption scheduled for October 1, 2014.
- The A400M cargo-system program involves significant capitalized development costs of $141.2 million, including $111.4 million in non-current assets. Recovery depends on certification, production cost reductions, program deliveries, and favorable resolution of negotiations with Airbus regarding responsibilities and pricing.
- Unbilled accounts receivable related to the KC-10 supply agreement totaled $19.1 million, and costs in excess of amounts billed for the same program totaled $8.6 million.
- Foreign exchange remains a risk; management estimated that a hypothetical 10% U.S. dollar devaluation against foreign currencies would have reduced quarterly pretax income by approximately $3 million.
- Additional risks include further reductions in defense or Afghanistan activity, aircraft-sale execution, new-program cost overruns, customer concentration, and execution risks associated with expanded aviation services.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether new expeditionary airlift awards replace lost Afghanistan revenue and support recovery in aircraft utilization.
- The timing and economics of the A400M program, including certification, negotiated pricing, production costs, and recoverability of capitalized development costs.
- Cash generation and working-capital needs, particularly the increases in inventory and receivables.
- Liquidity after the October 2014 convertible-note redemption and the April 2015 secured-facility maturity.
- Whether commercial supply-chain growth and cost controls can offset continued government and defense weakness.
- The filing text does not provide clear full-year revenue, earnings, margin, or cash-flow guidance.