AAR CORP - Quarter Report: 2010 August (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended August 31, 2010

 

or

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from               to               

 

Commission File No. 1-6263

 

AAR CORP.

(Exact name of registrant as specified in its charter)

 

 

 

(630) 227-2000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

As of August 31, 2010, there were 39,662,816 shares of the registrant’s Common Stock, $1.00 par value per share, outstanding.

 

 

Table of Contents

 

AAR CORP. and Subsidiaries

Quarterly Report on Form 10-Q

For the Quarter Ended August 31, 2010

Table of Contents

 

			Page
Part I — FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets		3-4
	Condensed Consolidated Statements of Income		5
	Condensed Consolidated Statements of Cash Flows		6
	Condensed Consolidated Statement of Changes in Equity		7
	Notes to Condensed Consolidated Financial Statements		8-18
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		19-24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		24
Item 4.	Controls and Procedures		24
Part II — OTHER INFORMATION
Item 1A.	Risk Factors		25
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		25
Item 6.	Exhibits		25
Signature Page			26
Exhibit Index			27

 

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PART I — FINANCIAL INFORMATION

 

Item 1 — Financial Statements

 

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of August 31, 2010 and May 31, 2010

(In thousands)

 

		August 31,			May 31,
		2010			2010
		(Unaudited)
Assets:
Current assets:
Cash and cash equivalents		$	52,155		$	79,370
Accounts receivable, less allowances of $4,783 and $4,773, respectively		245,096			238,466
Inventories		378,171			370,282
Rotable spares and equipment on or available for short-term lease		141,830			126,622
Deposits, prepaids and other		33,516			27,194
Deferred tax assets		21,495			21,495
Total current assets		872,263			863,429
Property, plant and equipment, net of accumulated depreciation of $202,940 and $194,139, respectively		250,492			224,866
Other assets:
Goodwill and other intangible assets, net		165,731			169,253
Equipment on long-term lease		104,920			109,564
Investment in joint ventures		47,744			48,433
Other		91,583			85,497
		409,978			412,747
		$	1,532,733		$	1,501,042

 

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

 

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AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of August 31, 2010 and May 31, 2010

(In thousands)

 

		August 31,			May 31,
		2010			2010
		(Unaudited)
Liabilities and equity:
Current liabilities:
Short-term debt		$	60,000		$	45,009
Current maturities of long-term debt		53,278			53,292
Current maturities of non-recourse long-term debt		773			757
Current maturities of long-term capital lease obligations		1,827			1,775
Accounts payable		130,112			114,906
Accrued liabilities		103,243			109,811
Total current liabilities		349,233			325,550
Long-term debt, less current maturities		313,191			317,594
Non-recourse debt		11,655			11,855
Capital lease obligations		6,253			6,742
Deferred tax liabilities		58,138			57,335
Other liabilities and deferred income		34,604			35,616
		423,841			429,142
Equity:
Preferred stock, $1.00 par value, authorized 250 shares; none issued		—			—
Common stock, $1.00 par value, authorized 100,000 shares; issued 45,262 and 44,870 shares, respectively		45,262			44,870
Capital surplus		419,577			416,842
Retained earnings		432,961			419,287
Treasury stock, 5,599 and 5,386 shares at cost, respectively		(108,049		)	(104,447		)
Accumulated other comprehensive loss		(29,536		)	(29,646		)
Total AAR shareholders’ equity		760,215			746,906
Noncontrolling interest		(556		)	(556		)
Total equity		759,659			746,350
		$	1,532,733		$	1,501,042

 

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

 

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AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Income

For the Three Months Ended August 31, 2010 and 2009

(Unaudited)

(In thousands, except per share data)

 

		Three Months Ended August 31,
		2010			2009
Sales:
Sales from products		$	287,709		$	272,529
Sales from services		124,488			68,994
		412,197			341,523
Cost and operating expenses:
Cost of products		242,352			243,469
Cost of services		98,957			44,031
Selling, general and administrative		42,705			36,892
		384,014			324,392
Earnings from joint ventures		28			83
Operating income		28,211			17,214
Gain on extinguishment of debt		97			913
Interest expense		(7,431		)	(6,557		)
Interest income		160			316
Income before provision for income taxes		21,037			11,886
Provision for income taxes		7,363			2,728
Net income attributable to AAR and noncontrolling interest		13,674			9,158
Loss attributable to noncontrolling interest		—			1,046
Net income attributable to AAR		$	13,674		$	10,204
Earnings per share – basic		$	0.36		$	0.27
Earnings per share – diluted		$	0.35		$	0.27
Weighted average common shares outstanding – basic		38,411			38,090
Weighted average common shares outstanding – diluted		42,854			42,574

 

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

 

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AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

For the Three Months Ended August 31, 2010 and 2009

(Unaudited)

(In thousands)

 

		Three Months Ended August 31,
		2010			2009
Cash flows from operating activities:
Net income attributable to AAR and noncontrolling interest		$	13,674		$	9,158
Adjustments to reconcile net income attributable to AAR and noncontrolling interest to net cash provided from operating activities:
Depreciation and amortization		14,367			8,697
Amortization of debt discount		3,011			2,867
Deferred tax provision		1,352			(5,609		)
Tax benefits from exercise of stock options		(1		)	(189		)
Gain on extinguishment of debt		(97		)	(913		)
Earnings from joint ventures		(28		)	(83		)
Changes in certain assets and liabilities:
Accounts and notes receivable		(2,859		)	24,469
Inventories		(8,482		)	3,046
Rotable spares and equipment on or available for short-term lease		(15,276		)	7,795
Equipment on long-term lease		2,076			2,407
Accounts payable		15,221			(6,369		)
Accrued liabilities		(7,206		)	(14,249		)
Other liabilities		109			87
Other, primarily deposits and program costs		(8,643		)	3,008
Net cash provided from operating activities		7,218			34,122
Cash flows from investing activities:
Property, plant and equipment expenditures		(37,046		)	(8,943		)
Proceeds from disposal of assets		15			30
Proceeds from aircraft joint ventures		598			37
Investment in aircraft joint ventures		(1,207		)	(472		)
Proceeds from leveraged leases		—			5,220
Other		(1,188		)	(984		)
Net cash used in investing activities		(38,828		)	(5,112		)
Cash flows from financing activities:
Change in short-term borrowings, net		14,991			103
Reduction in borrowings		(7,446		)	(18,768		)
Reduction in capital lease obligations		(436		)	(540		)
Reduction in equity due to convertible bond repurchases		(236		)	(254		)
Purchase of treasury stock		(2,539		)	—
Stock option exercises		47			323
Tax benefits from exercise of stock options		1			189
Contributions from noncontrolling interest		—			231
Net cash provided from (used in) financing activities		4,382			(18,716		)
Effect of exchange rate changes on cash		13			41
Increase (decrease) in cash and cash equivalents		(27,215		)	10,335
Cash and cash equivalents, beginning of period		79,370			112,505
Cash and cash equivalents, end of period		$	52,155		$	122,840

 

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

 

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AAR CORP. and Subsidiaries

Condensed Consolidated Statement of Changes in Equity

For the Three Months Ended August 31, 2010

(Unaudited)

(In thousands)

 

		Common Stock			Treasury Stock			Capital Surplus			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total AAR Stockholders’ Equity			Noncontrolling Interest			Total Equity
Balance, May 31, 2010		$	44,870		$	(104,447	)	$	416,842		$	419,287		$	(29,646	)	$	746,906		$	(556	)	$	746,350
Net income		—			—			—			13,674			—			13,674			—			13,674
Exercise of stock options and stock awards		4			(926		)	938			—			—			16			—			16
Restricted stock activity		388			—			1,347			—			—			1,735			—			1,735
Repurchase of shares		—			(2,539		)	—			—			—			(2,539		)	—			(2,539		)
Bond hedge and warrant activity		—			(137		)	137			—			—			—			—			—
Equity portion of bond repurchase		—			—			313			—			—			313			—			313
Foreign currency translation gain		—			—			—			—			110			110			—			110
Balance, August 31, 2010		$	45,262		$	(108,049	)	$	419,577		$	432,961		$	(29,536	)	$	760,215		$	(556	)	$	759,659

 

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

 

Note 1 — Basis of Presentation

 

AAR CORP. and its subsidiaries are referred to herein collectively as “AAR,” “Company,” “we,” “us,” and “our” unless the context indicates otherwise.  The accompanying condensed consolidated financial statements include the accounts of AAR and its subsidiaries after elimination of intercompany accounts and transactions.

 

We have prepared these statements without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”).  The condensed consolidated balance sheet as of May 31, 2010 has been derived from audited financial statements.  To prepare the financial statements in conformity with U.S. generally accepted accounting principles, management has made a number of estimates and assumptions relating to the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities.  Actual results could differ from those estimates.  Certain information and note disclosures, normally included in comprehensive financial statements prepared in accordance with U.S. generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations of the SEC.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our latest annual report on Form 10-K.

 

In the opinion of management, the condensed consolidated financial statements reflect all adjustments (which consist only of normal recurring adjustments) necessary to present fairly the condensed consolidated financial position of AAR CORP. and its subsidiaries as of August 31, 2010, the condensed consolidated statements of income and cash flows for the three-month periods ended August 31, 2010 and 2009 and the condensed consolidated statement of changes in equity for the three-month period ended August 31, 2010.  The results of operations for such interim periods are not necessarily indicative of the results for the full year.

 

Note 2 — Accounting for Stock-Based Compensation

 

We provide stock-based awards under the AAR CORP. Stock Benefit Plan (“Stock Benefit Plan”) which has been approved by our stockholders.  Under this plan, we are authorized to issue stock options to employees and non-employee directors that allow the grant recipients to purchase shares of common stock at a price not less than the fair market value of the common stock on the date of grant.  Generally, stock options awarded expire ten years from the date of grant and are exercisable in three, four or five equal annual increments commencing one year after the date of grant.  We issue common stock upon the exercise of stock options.  In addition to stock options, the Stock Benefit Plan also provides for the grant of restricted stock awards and performance based restricted stock awards.  The amount of performance-based awards earned is based on achievement of certain company wide financial goals or stock price targets.  The Stock Benefit Plan also provides for the grant of stock appreciation units; however, to date, no stock appreciation units have been granted.

 

We measure share-based compensation based on the fair value of the award at the grant date, and recognize the cost of share-based awards over the applicable service period, which is generally the vesting period.  Performance-based restricted stock compensation is recognized over the applicable service period and based on the level of achievement that is considered probable.

 

During the three-month periods ended August 31, 2010 and 2009, we granted stock options representing 691,471 shares and 687,000 shares, respectively.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

 

The weighted average fair value of stock options granted during the three-month periods ended August 31, 2010 and 2009 was $7.94 and $7.40, respectively.  The fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

 

		Three Months Ended
		August 31,
		2010		2009
Risk-free interest rate		1.9	%	2.3	%
Expected volatility of common stock		47.0	%	49.2	%
Dividend yield		0.0	%	0.0	%
Expected option term in years		5.8		6.0

 

The following table summarizes stock option activity for the three-month period ended August 31, 2010:

 

							Weighted
				Weighted			Average
		Number of		Average			Remaining		Aggregate
		Options		Exercise			Contractual		Intrinsic
		(in thousands)		Price			Life (years)		Value
Outstanding at May 31, 2010		1,543		$	19.28
Granted		691		$	17.27
Exercised		(3	)	$	15.51
Cancelled		(42	)	$	23.80
Outstanding at August 31, 2010		2,189		$	18.51		5.6		$	831
Exercisable at August 31, 2010		911		$	19.82		5.5		$	715

 

The total fair value of stock options that vested during the three-month periods ended August 31, 2010 and 2009 was $2,275 and $682, respectively.  The total intrinsic value of stock options exercised during the three-month periods ended August 31, 2010 and 2009 was $4 and $534, respectively.  The tax benefit realized from stock options exercised during the three-month periods ended August 31, 2010 and 2009 was $1 and $189, respectively.  Expense charged to operations for stock options during the three-month periods ended August 31, 2010 and 2009 was $888 and $407, respectively.  As of August 31, 2010, we had $9,930 of unearned compensation related to stock options that will be amortized over an average remaining period of 2.5 years.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

 

The fair value of restricted stock awards is the market value of our common stock on the date of grant.  Amortization expense related to restricted stock awards during the three-month periods ended August 31, 2010 and 2009 was $1,735 and $1,415, respectively.

 

Restricted share activity during the three-month period ended August 31, 2010 is as follows:

 

		Number of		Weighted Average
		Shares		Fair Value
		(in thousands)		on Grant Date
Unvested at May 31, 2010		1,205		$	23.93
Granted		400		$	17.32
Vested		(210	)	$	17.62
Forfeited		(12	)	$	20.53
Unvested at August 31, 2010		1,383		$	23.01

 

During the three-month period ended August 31, 2010, we granted a total of 36,000 restricted shares to members of the Board of Directors.  As of August 31, 2010 we had $18,528 of unearned compensation related to restricted shares that will be amortized to expense over a weighted average period of 2.8 years.

 

Stock Repurchase Authorization

 

On June 20, 2006 our Board of Directors authorized us to purchase up to 1,500,000 shares of our common stock on the open market.  During the first quarter of fiscal 2011, we purchased 150,000 shares of our common stock on the open market at an average price of $16.92, leaving 1,028,300 shares still available for repurchase.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

 

Note 3 — Inventory

 

The summary of inventories is as follows:

 

		August 31,			May 31,
		2010			2010
Raw materials and parts		$	66,206		$	62,737
Work-in-process		57,411			51,523
Purchased aircraft, parts, engines and components held for sale		254,554			256,022
		$	378,171		$	370,282

 

Note 4 — Supplemental Cash Flow Information

 

		Three Months Ended
		August 31,
		2010			2009
Interest paid		$	3,609		$	4,154
Income taxes paid		3,053			6,382
Income tax refunds received		67			55

 

Note 5 — Comprehensive Income

 

A summary of the components of comprehensive income is as follows:

 

		Three Months Ended
		August 31,
		2010			2009
Net income attributable to AAR and noncontrolling interest		$	13,674		$	10,204
Other comprehensive income —
Cumulative translation adjustments		110			432
Total comprehensive income		$	13,784		$	10,636

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

 

Note 6 — Financing Arrangements

 

A summary of our recourse and non-recourse long-term debt is as follows:

 

		August 31,			May 31,
		2010			2010
Recourse debt
Notes payable due May 15, 2011 with interest at 8.39% payable semi-annually on June 1 and December 1		$	42,000		$	42,000
Note payable due July 19, 2012 with interest at 7.22%, payable monthly		3,657			4,116
Note payable due May 1, 2015 with interest at 3.5%, payable monthly		61,905			64,225
Mortgage loan (secured by Wood Dale, Illinois facility) due August 1, 2015 with interest at 5.01%		11,000			11,000
Convertible notes payable due March 1, 2014 with interest at 1.625% payable semi-annually on March 1 and September 1		70,801			69,957
Convertible notes payable due March 1, 2016 with interest at 2.25% payable semi-annually on March 1 and September 1		49,623			53,652
Convertible notes payable due February 1, 2026 with interest at 1.75% payable semi-annually on February 1 and August 1		102,425			100,828
Industrial revenue bonds (secured by trust indenture on property, plant and equipment) due December 1, 2010 and August 1, 2018 with floating interest rate, payable monthly		25,058			25,108
Total recourse debt		366,469			370,886
Current maturities of recourse debt		(53,278		)	(53,292		)
Long-term recourse debt		$	313,191		$	317,594
Non-recourse debt
Non-recourse note payable due July 19, 2012 with interest at 7.22%		$	8,201		$	8,201
Non-recourse note payable due April 3, 2015 with interest at 8.38%		4,227			4,411
Total non-recourse debt		12,428			12,612
Current maturities of non-recourse debt		(773		)	(757		)
Long-term non-recourse debt		$	11,655		$	11,855

 

During the first quarter of fiscal 2011, we retired $6,000 par value of our 2.25% convertible notes due March 1, 2010.  The notes were retired for $4,667 cash, and the gain of $97, after consideration of unamortized discount and debt issuance costs, is recorded in gain on extinguishment of debt on the condensed consolidated statements of income.

 

During the first quarter of fiscal 2010, we retired $10,500 par value of our 1.625% convertible notes due March 1, 2014 and $2,000 par value of our 2.25% convertible notes due March 1, 2016.  Collectively, the convertible notes were retired for $9,115 cash, and the gain of $913, after consideration of unamortized discount and debt issuance costs, is recorded in gain on extinguishment of debt on the condensed consolidated statements of income.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

 

At August 31, 2010, the face value of our long-term recourse debt was $412,000 and the estimated fair value was approximately $374,000.  The fair value was estimated using available market information.

 

Change in method of accounting for Convertible Notes

 

On June 1, 2009, we adopted a new accounting standard that clarifies the accounting for convertible debt instruments that may be settled wholly or partly in cash when converted, and requires convertible debt to be accounted for as two components: (i) a debt component which is recorded upon issuance at the estimated fair value of a similar straight-debt instrument without the debt-for-equity conversion feature; and (ii) an equity component that is included in capital surplus and represents the estimated fair value of the conversion feature at issuance.  The bifurcation of the debt and equity components results in a discounted carrying value of the debt component compared to the principal amount.  The discount is accreted to the carrying value of the debt component through interest expense over the expected life of the debt using the effective interest method.

 

As of August 31, 2010 and May 31, 2010, the long-term debt and equity component (recorded in capital surplus, net of income tax benefit) consisted of the following:

 

		August 31,			May 31,
		2010			2010
Long-term debt:
Principal amount		$	268,380		$	274,380
Unamortized discount		(45,531		)	(49,943		)
Net carrying amount		$	222,849		$	224,437
Equity component, net of tax		$	74,966		$	74,653

 

The discount on the liability component of long-term debt is being amortized using the effective interest method based on an effective rate of 8.48% for our 1.75% convertible notes; 6.82% for our 1.625% convertible notes and 7.41% for our 2.25% convertible notes.  For our 1.75% convertible notes, the discount is being amortized through February 1, 2013, which is the first put date for those notes.  For our 1.625% and 2.25% convertible notes, the discount is being amortized through their respective maturity dates of March 1, 2014 and March 1, 2016.

 

As of August 31, 2010, for each of our convertible note issuances, the “if converted” value does not exceed its principal amount.

 

The interest expense associated with the convertible notes was as follows:

 

		Three Months Ended
		August 31,
		2010			2009
Coupon interest		$	1,247		$	1,288
Amortization of deferred financing fees		189			195
Amortization of discount		3,011			2,867
Interest expense related to convertible notes		$	4,447		$	4,350

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

 

Note 7 — Earnings per Share

 

The computation of basic earnings per share is based on the weighted average number of common shares outstanding during each period.  The computation of diluted earnings per share is based on the weighted average number of common shares outstanding during the period plus, when their effect is dilutive, incremental shares consisting of shares subject to stock options, shares issuable upon vesting of restricted stock awards and shares to be issued upon conversion of convertible debt.

 

We use the “if-converted” method in calculating the diluted earnings per share effect of the assumed conversion of our contingently convertible debt issued in fiscal 2006 because the principal for that issuance can be settled in stock, cash or a combination thereof.  Under the “if converted” method, the after-tax effect of interest expense related to the convertible securities is added back to net income, and the convertible debt is assumed to have been converted into common shares at the beginning of the period.

 

The following table provides a reconciliation of the computations of basic and diluted earnings per share information for the three-month periods ended August 31, 2010 and 2009.

 

		Three Months Ended
		August 31,
		2010			2009
Net income attributable to AAR		$	13,674		$	10,204
Basic shares:
Weighted average common shares outstanding		38,411			38,090
Earnings per share — basic		$	0.36		$	0.27
Net income attributable to AAR		$	13,674		$	10,204
Add: After-tax interest on convertible debt		1,371			1,288
Net income for diluted EPS calculation		$	15,045		$	11,492
Diluted shares:
Weighted average common shares outstanding		38,411			38,090
Additional shares from the assumed exercise of stock options		85			110
Additional shares from the assumed vesting of restricted stock		290			306
Additional shares from the assumed conversion of convertible debt		4,068			4,068
Weighted average common shares outstanding — diluted		42,854			42,574
Earnings per share — diluted		$	0.35		$	0.27

 

At August 31, 2010 and 2009, respectively, stock options to purchase 1,232,000 and 631,000 shares of common stock were outstanding, but were not included in the computation of diluted earnings

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

 

per share because the exercise price of each of these options was greater than the average market price of the common shares during the interim periods then ended.

 

Note 8 —Aircraft Portfolio

 

Within our Aviation Supply Chain segment, we own commercial aircraft with joint venture partners as well as aircraft that are wholly-owned.  These aircraft are available for lease or sale to commercial air carriers.

 

Joint Ventures

 

As of August 31, 2010, the Company had ownership interests in 26 aircraft with joint venture partners.  As of August 31, 2010, our equity investment in the 26 aircraft owned with joint venture partners was approximately $41,169 and is included in investment in joint ventures on the Condensed Consolidated Balance Sheet.  Our aircraft joint ventures represent investments in limited liability companies that are accounted for under the equity method of accounting.  Our membership interest in each of these limited liability companies is 50% and the primary business of these companies is the acquisition, ownership, lease and disposition of certain commercial aircraft.  Aircraft are purchased with cash contributions by the members of the companies and debt financing provided to the limited liability companies on a limited recourse basis.  Under the terms of servicing agreements with certain of the limited liability companies, we provide administrative services and technical advisory services, including aircraft evaluations, oversight and logistical support of the maintenance process and records management.  We also provide remarketing services with respect to the divestiture of aircraft by the limited liability companies.  For the three-month periods ended August 31, 2010 and 2009, we were paid $212 and $196, respectively, for such services.    The income tax benefit or expense related to the operations of the ventures is recorded by the member companies.

 

Distributions from joint ventures are classified as operating or investing activities in the consolidated statements of cash flows based upon an evaluation of the specific facts and circumstances of each distribution.

 

Summarized financial information for these limited liability companies is as follows:

 

		Three Months Ended
		August 31,
		2010			2009
Sales		$	12,266		$	11,264
Income before provision for income taxes		254			356

 

		August 31,			May 31,
		2010			2010
Balance sheet information:
Assets		$	250,464		$	259,965
Debt		159,100			167,255
Members’ capital		88,018			89,449

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

 

Wholly-Owned Aircraft

 

In addition to the aircraft owned with joint venture partners, we own five aircraft for our own account.  A former lessee of two of our wholly-owned aircraft is in arrears for amounts due under the leases.  We have obtained a judgment against the lessee and its affiliated guarantor and expect to recover past due rental amounts.  Our net investments in these two aircraft after consideration of non-recourse financing are $7,426 and $5,246, respectively.  Our investment in the five wholly-owned aircraft, after consideration of financing, is comprised of the following components: 

 

		August 31,			May 31,
		2010			2010
Gross carrying value		$	50,518		$	50,854
Non-recourse debt		(16,085		)	(16,728		)
Non-recourse capital lease obligation		(8,061		)	(8,492		)
Net AAR investment		$	26,372		$	25,634

 

Information relating to aircraft type, year of manufacture, lessee, lease expiration date and expected disposition upon lease expiration for the 26 aircraft owned with joint venture partners and five wholly-owned aircraft is as follows:

 

Aircraft owned with joint venture partners

 

				Year				Lease Expiration		Post-Lease
Quantity		Aircraft Type		Manufactured		Lessee		Date (FY)		Disposition
2		737-300		1987		US Airways		2011,2012		Re-lease/Disassemble
2		767-300		1991		United Airlines		2016 and 2017		Re-lease
1		757-200		1989		US Airways		2012		Forward Sale 11/2011
1		747-400		1989		Delta Airlines		2014		Re-lease/Disassemble
1		737-300		1997		flyLAL Charters		2013		Re-lease
1		A320		1992		Air Canada		2015		Disassemble
18		737-400		1992-1997		Malaysia Airlines		Various(1)		Re-lease
26

 

Wholly-owned aircraft

 

				Year				Lease Expiration		Post-Lease
Quantity		Aircraft Type		Manufactured		Lessee		Date (FY)		Disposition
1		MD83		1989		Meridiana		2011		Sale/Re-lease
2		A320		1992, 1997		Available		—		Re-lease
1		A320		1992		Air Canada		2015		Re-lease
1		CRJ 200		1999		Air Wisconsin		2017		Sale/Disassemble
5

 

(1)  5 aircraft in 2011; 11 aircraft in 2012 and 2 aircraft in 2013

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

 

Note 9 — Business Segment Information

 

We report our activities in four business segments: Aviation Supply Chain; Government and Defense Services; Maintenance, Repair and Overhaul; and Structures and Systems.  In fiscal 2010, we revised our segments to align with the way our Chief Executive Officer evaluates performance and the way we are internally organized.  Prior year information was revised to conform with our new segment presentation.

 

Sales in the Aviation Supply Chain segment are derived from the sale and lease of a wide variety of new, overhauled and repaired engine and airframe parts and components principally to the commercial aviation market.  We also offer customized inventory supply chain management programs.  Sales also include the sale and lease of commercial aircraft and jet engines and technical and advisory services.  Cost of sales consists principally of the cost of product, direct labor, overhead (primarily indirect labor, facility cost and insurance) and the cost of lease revenue (primarily depreciation and insurance).

 

Sales in the Government and Defense Services segment are derived from the sale of new and overhauled engine and airframe parts and components, customized performance based logistics programs, expeditionary airlift services, aircraft modifications and engineering, design, and integration services to our government and defense customers.  Cost of sales consists principally of the cost of the product (primarily aircraft and engine parts), direct labor, overhead and aircraft maintenance costs.

 

Sales in the Maintenance, Repair and Overhaul segment are principally derived from aircraft maintenance, including painting, and the repair and overhaul of landing gear.  Cost of sales consists principally of the cost of product (primarily replacement aircraft parts), direct labor and overhead.

 

Sales in the Structures and Systems segment are derived from the engineering, design and manufacture of containers, pallets and shelters used to support the U.S. military’s tactical deployment requirements, complex machined and fabricated parts, components and sub-systems for various aerospace and defense programs and other applications, in-plane cargo loading and handling systems for commercial and military applications and composite products for aviation and industrial use.  Cost of sales consists principally of the cost of product, direct labor and overhead.

 

The accounting policies for the segments are the same as those described in Note 1 of Notes to Consolidated Financial Statements included in our annual report on Form 10-K for the year ended May 31, 2010.  Our chief operating decision making officer (Chief Executive Officer) evaluates performance based on the reportable segments and utilizes gross profit as a primary profitability measure.  The expenses and assets related to corporate activities are not allocated to the segments.  Our reportable segments are aligned principally around differences in products and services.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

 

Gross profit is calculated by subtracting cost of sales from sales.  Selected financial information for each reportable segment is as follows:

 

		Three Months Ended
		August 31,
		2010			2009
Sales:
Aviation Supply Chain		$	108,070		$	110,637
Government and Defense Services		129,330			36,743
Maintenance, Repair and Overhaul		76,819			79,217
Structures and Systems		97,978			114,926
		$	412,197		$	341,523

 

		Three Months Ended
		August 31,
		2010			2009
Gross profit:
Aviation Supply Chain		$	20,127		$	15,965
Government and Defense Services		23,022			7,705
Maintenance, Repair and Overhaul		10,107			10,539
Structures and Systems		17,632			19,814
		$	70,888		$	54,023

 

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