AAR CORP - Quarter Report: 2011 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, 2011

 

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, 2011, there were 40,460,631 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, 2011

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	8-20
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		21-26
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		26
	Item 4.	Controls and Procedures		26
Part II — OTHER INFORMATION
	Item 1A.	Risk Factors		27
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		27
	Item 6.	Exhibits		27
	Signature Page			28
	Exhibit Index			29

 

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PART I — FINANCIAL INFORMATION

 

Item 1 — Financial Statements

 

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of August 31, 2011 and May 31, 2011

(In thousands)

 

		August 31,			May 31,
		2011			2011
		(Unaudited)
Assets:
Current assets:
Cash and cash equivalents		$	35,523		$	57,433
Accounts receivable, less allowances of $5,615 and $5,719, respectively		296,382			287,435
Inventories		402,740			363,399
Rotable spares and equipment on or available for short-term lease		146,189			143,875
Deposits, prepaids and other		39,830			38,260
Deferred tax assets		23,583			23,583
Total current assets		944,247			913,985
Property, plant and equipment, net of accumulated depreciation of $246,183 and $235,098, respectively		335,269			324,377
Other assets:
Goodwill and other intangible assets, net		179,145			181,097
Equipment on long-term lease		76,304			93,387
Investment in joint ventures		44,256			48,743
Other		173,151			142,138
		472,856			465,365
		$	1,752,372		$	1,703,727

 

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, 2011 and May 31, 2011

(In thousands)

 

		August 31			May 31,
		2011			2011
		(Unaudited)
Liabilities and equity:
Current liabilities:
Short-term debt		$	50,000		$	100,000
Current maturities of long-term debt		19,208			11,323
Current maturities of non-recourse long-term debt		840			823
Current maturities of long-term capital lease obligations		6,334			1,929
Accounts and trade notes payable		168,791			185,096
Accrued liabilities		104,912			116,839
Total current liabilities		350,085			416,010
Long-term debt, less current maturities		414,700			313,981
Non-recourse debt		2,615			11,032
Capital lease obligations		148			4,789
Deferred tax liabilities		99,871			98,322
Other liabilities and deferred income		35,824			24,304
		553,158			452,428
Equity:
Preferred stock, $1.00 par value, authorized 250 shares; none issued		—			—
Common stock, $1.00 par value, authorized 100,000 shares; issued 44,934 and 44,986 shares, respectively		44,934			44,986
Capital surplus		412,924			423,805
Retained earnings		499,745			486,130
Treasury stock, 4,473 and 5,205 shares at cost, respectively		(86,856		)	(100,431		)
Accumulated other comprehensive loss		(21,062		)	(18,645		)
Total AAR shareholders’ equity		849,685			835,845
Noncontrolling interest		(556		)	(556		)
Total equity		849,129			835,289
		$	1,752,372		$	1,703,727

 

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, 2011 and 2010

(Unaudited)

(In thousands, except per share data)

 

		Three Months Ended
		August 31,
		2011			2010
Sales:
Sales from products		$	327,898		$	281,756
Sales from services		151,392			122,637
		479,290			404,393
Cost and operating expenses:
Cost of products		287,362			237,209
Cost of services		117,088			97,183
Selling, general and administrative		41,730			41,242
		446,180			375,634
Earnings from joint ventures		205			28
Operating income		33,315			28,787
Gain on extinguishment of debt		—			97
Interest expense		(7,518		)	(7,433		)
Interest income		104			160
Income from continuing operations before provision for income taxes		25,901			21,611
Provision for income taxes		8,938			7,564
Income from continuing operations		16,963			14,047
Discontinued operations, net of tax		(314		)	(373		)
Net income		$	16,649		$	13,674
Earnings per share — basic:
Earnings from continuing operations		$	0.42		$	0.37
Loss from discontinued operations		$	(0.01	)	$	(0.01	)
Earnings per share — basic		$	0.41		$	0.36
Earnings per share — diluted:
Earnings from continuing operations		$	0.41		$	0.36
Loss from discontinued operations		$	—		$	(0.01	)
Earnings per share — diluted		$	0.41		$	0.35

 

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, 2011 and 2010

(Unaudited)

(In thousands)

 

		Three Months Ended
		August 31,
		2011			2010
Cash flows from operating activities:
Net income		$	16,649		$	13,674
Adjustments to reconcile net income to net cash provided from (used in) operating activities:
Depreciation and amortization		16,699			14,367
Amortization of stock-based compensation		2,617			2,623
Amortization of debt discount		3,220			3,011
Deferred tax provision		2,779			1,352
Tax benefits from exercise of stock options		(765		)	(1		)
Gain on extinguishment of debt		—			(97		)
Earnings from joint ventures		(205		)	(28		)
Changes in certain assets and liabilities:
Accounts receivable		(9,001		)	(2,859		)
Inventories		(36,755		)	(8,482		)
Rotable spares and equipment on or available for short-term lease		(8,269		)	(15,276		)
Equipment on long-term lease		19,446			2,076
Accounts and trade notes payable		4,993			15,221
Accrued and other liabilities		(5,115		)	(7,097		)
Other, primarily deposits and program costs		(31,905		)	(11,266		)
Net cash provided from (used in) operating activities		(25,612		)	7,218
Cash flows from investing activities:
Property, plant and equipment expenditures		(41,751		)	(37,046		)
Proceeds from disposal of assets		—			15
Proceeds from aircraft joint ventures		—			598
Investment in aircraft joint ventures		(401		)	(1,207		)
Other		(109		)	(1,188		)
Net cash used in investing activities		(42,261		)	(38,828		)
Cash flows from financing activities:
Change in short-term borrowings		50,000			14,991
Reduction in borrowings		(3,060		)	(7,446		)
Reduction in capital lease obligations		(471		)	(436		)
Reduction in equity due to convertible bond repurchases		—			(236		)
Cash dividends		(3,034		)	—
Purchase of treasury stock		(1,038		)	(2,539		)
Stock option exercises		2,897			47
Tax benefits from exercise of stock options		765			1
Net cash provided from financing activities		46,059			4,382
Effect of exchange rate changes on cash		(96		)	13
Decrease in cash and cash equivalents		(21,910		)	(27,215		)
Cash and cash equivalents, beginning of period		57,433			79,370
Cash and cash equivalents, end of period		$	35,523		$	52,155

 

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, 2011

(Unaudited)

(In thousands)

 

														Accumulated
														Other			Total AAR
		Common			Capital			Retained			Treasury			Comprehensive			Shareholders’			Noncontrolling			Total
		Stock			Surplus			Earnings			Stock			Income (Loss)			Equity			Interest			Equity
Balance, May 31, 2011		$	44,986		$	423,805		$	486,130		$	(100,431	)	$	(18,645	)	$	835,845		$	(556	)	$	835,289
Net income		—			—			16,649			—			—			16,649			—			16,649
Cash dividends		—			—			(3,034		)	—			—			(3,034		)	—			(3,034		)
Exercise of stock options and stock awards		—			(478		)	—			1,533			—			1,055			—			1,055
Tax benefit related to share-based plans		—			639			—			—			—			639			—			639
Restricted stock activity		(52		)	(11,042		)	—			13,080			—			1,986			—			1,986
Repurchase of shares		—			—			—			(1,038		)	—			(1,038		)	—			(1,038		)
Unrealized loss on derivatives, net of tax		—			—			—			—			(2,515		)	(2,515		)	—			(2,515		)
Foreign currency translation gain		—			—			—			—			98			98			—			98
Balance, August 31, 2011		$	44,934		$	412,924		$	499,745		$	(86,856	)	$	(21,062	)	$	849,685		$	(556	)	$	849,129

 

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, 2011

(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, 2011 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, 2011, the condensed consolidated statements of income for the three-month periods ended August 31, 2011 and 2010, its cash flows for the three-month periods ended August 31, 2011 and 2010 and the condensed consolidated statement of changes in equity for the three-month period ended August 31, 2011.  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 the Stock Benefit 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 number 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 and restricted stock units; however, to date, no such awards 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, 2011 and 2010, we granted stock options representing 157,281 shares and 691,471 shares, respectively.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2011

(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, 2011 and 2010 was $11.80 and $7.94, 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,
		2011		2010
Risk-free interest rate		1.5	%	1.9	%
Expected volatility of common stock		45.7	%	47.0	%
Dividend yield		1.0	%	0.0	%
Expected option term in years		5.7		5.8

 

The following table summarizes stock option activity for the three-month period ended August 31, 2011:

 

							Weighted
				Weighted			Average
		Number of		Average			Remaining		Aggregate
		Options		Exercise			Contractual		Intrinsic
		(in thousands)		Price			Life (years)		Value
Outstanding at May 31, 2011		1,994		$	18.56
Granted		157		$	29.30
Exercised		(332	)	$	20.03
Cancelled		(31	)	$	17.11
Outstanding at August 31, 2011		1,788		$	19.66		6.9		$	11,362
Exercisable at August 31, 2011		866		$	18.28		4.4		$	6,427

 

The total fair value of stock options that vested during the three-month periods ended August 31, 2011 and 2010 was $3,720 and $2,275, respectively.  The total intrinsic value of stock options exercised during the three-month periods ended August 31, 2011 and 2010 was $3,323 and $4, respectively.  The tax benefit realized from stock options exercised during the three-month periods ended August 31, 2011 and 2010 was $639 and $1, respectively.  Expense charged to operations for stock options during the three-month periods ended August 31, 2011 and 2010 was $1,099 and $888, respectively.  As of August 31, 2011, we had $7,170 of unearned compensation related to stock options that will be amortized over an average remaining period of 1.4 years.

 

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, 2011 and 2010 was $1,518 and $1,735, respectively.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

 

Restricted share activity during the three-month period ended August 31, 2011 is as follows:

 

		Number of		Weighted Average
		Shares		Fair Value
		(in thousands)		on Grant Date
Unvested at May 31, 2011		1,374		$	23.06
Granted		598		$	23.99
Vested		(324	)	$	26.71
Forfeited		(49	)	$	24.54
Unvested at August 31, 2011		1,599		$	22.61

 

During the three-month period ended August 31, 2011, we granted a total of 45,000 restricted shares to members of the Board of Directors.  As of August 31, 2011 we had $25,373 of unearned compensation related to restricted shares that will be amortized to expense over a weighted average period of 2.7 years.

 

Note 3 — Inventory

 

The summary of inventories is as follows:

 

		August 31,			May 31,
		2011			2011
Raw materials and parts		$	63,053		$	61,314
Work-in-process		61,913			51,725
Purchased aircraft, parts, engines and components held for sale		277,774			250,360
		$	402,740		$	363,399

 

Note 4 — Supplemental Cash Flow Information

 

		Three Months Ended
		August 31,
		2011			2010
Interest paid		$	3,158		$	3,609
Income taxes paid		1,905			3,053
Income tax refunds received		4,904			67

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

 

Note 5 — Comprehensive Income

 

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

 

		Three Months Ended
		August 31,
		2011			2010
Net income		$	16,649		$	13,674
Other comprehensive income —
Cumulative translation adjustments		98			110
Unrealized loss on derivative instruments, net of tax		(2,515		)	—
Total comprehensive income		$	14,232		$	13,784

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

 

Note 6 — Financing Arrangements

 

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

 

		August 31,			May 31,
		2011			2011
Recourse debt:
Revolving credit facility expiring April 12, 2016 with interest payable monthly (see Note 7)		$	150,000		$	100,000
Note payable due July 19, 2012 with interest at 7.22%, payable monthly		9,922			2,217
Note payable due May 1, 2015 with interest at 3.44%, payable monthly		52,619			54,940
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		74,320			73,418
Convertible notes payable due March 1, 2016 with interest at 2.25% payable semi-annually on March 1 and September 1		51,892			51,309
Convertible notes payable due February 1, 2026 with interest at 1.75% payable semi-annually on February 1 and August 1		109,155			107,420
Industrial revenue bond (secured by trust indenture on property, plant and equipment) due August 1, 2018 with floating interest rate, payable monthly		25,000			25,000
Total recourse debt		483,908			425,304
Current maturities of recourse debt		(69,208		)	(111,323		)
Long-term recourse debt		$	414,700		$	313,981
Non-recourse debt:
Non-recourse note payable due July 19, 2012 with interest at 7.22%		$	—		$	8,201
Non-recourse note payable due April 3, 2015 with interest at 8.38%		3,455			3,654
Total non-recourse debt		3,455			11,855
Current maturities of non-recourse debt		(840		)	(823		)
Long-term non-recourse debt		$	2,615		$	11,032

 

During the first quarter of fiscal 2012, the non-recourse note due July 19, 2012 became fully recourse to the Company and is presented in the recourse portion of the table above.

 

During the three-month period ended August 31, 2010, we retired $6,000 par value of our 2.25% convertible notes due March 1, 2016.  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.

 

At August 31, 2011, the face value of our long-term recourse debt was $447,713 and the estimated fair value was approximately $442,000.  The fair value was estimated using available market information.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

 

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, 2011 and May 31, 2011, the long-term debt and equity component (recorded in capital surplus, net of income tax benefit) consisted of the following:

 

		August 31,			May 31,
		2011			2011
Long-term debt:
Principal amount		$	268,380		$	268,380
Unamortized discount		(33,013		)	(36,233		)
Net carrying amount		$	235,367		$	232,147
Equity component, net of tax		$	74,966		$	74,966

 

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, 2011 and 2010, for each of our convertible note issuances, the “if converted” value does not exceed its principal amount.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

 

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

 

		Three Months Ended
		August 31,
		2011			2010
Coupon interest		$	1,228		$	1,247
Amortization of deferred financing fees		188			189
Amortization of discount		3,220			3,011
Interest expense related to convertible notes		$	4,636		$	4,447

 

Note 7 — Derivative Instruments and Hedging Activities

 

We are exposed to interest rate risk associated with fluctuations in interest rates on our variable rate debt.  During the first quarter of fiscal 2012, we entered into two derivative financial instruments in order to manage our variable interest rate exposure over a medium- to long-term period.  In June, we entered into a floating-to-fixed interest rate swap to hedge interest on $50,000 of notional principal balance under our revolving credit agreement.  Also in June, we entered into an interest rate cap agreement on $50,000 of notional principal interest under our revolving credit agreement.

 

We do not hold or issue derivative instruments for trading purposes and are not a party to any instruments with leverage or prepayment features.  In connection with derivative financial instruments, there exists the risk of the possible inability of counterparties to meet the terms of their contracts.  We mitigate this risk by performing financial reviews before the contract is entered into, as well as on-going periodic evaluations.  We do not expect any significant losses from counterparty defaults.

 

We classify the derivatives as assets or liabilities on the balance sheet.  Accounting for the change in fair value of the derivatives is a function of whether the instrument qualifies for, and has been designated as, a hedging relationship, and the type of hedging relationship.  As of August 31, 2011, all of our derivative instruments were classified as cash flow hedges.  The fair value of the interest rate swap and interest cap agreements represents the difference in the present values of cash flows calculated at the contracted interest rates and at current market interest rates at the end of the reporting period.

 

The fair value of the Company’s interest rate derivatives are classified as Level 2 in the fair value hierarchy. Level 2 refers to fair values estimated using significant other observable inputs including quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active. At August 31, 2011, the fair value of the Company’s interest rate derivatives was recorded as follows:

 

				Derivative			Derivative
				Assets			Liabilities
		Balance Sheet Classification		August 31, 2011			August 31, 2011
Derivatives designated as hedging instruments:
Interest rate cap		Long-term assets		$	759		$	—
Interest rate swap		Long-term liabilities		$	—		$	(2,880	)

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

 

We include gains and losses on the derivative instruments in other comprehensive income.  We recognize the gains and losses on our derivative instruments as an adjustment to interest expense in the period the hedged interest payment affects earnings.  The impact of the interest rate swap and interest cap agreement on the condensed consolidated statement of income for the three-month period ended August 31, 2011 was as follows:

 

		Three Months Ended
		August 31, 2011
Gain (loss) recognized in other comprehensive income — effective portion		$	(2,515	)
Gain (loss) reclassified from accumulated other comprehensive income into income		$	—
Gain (loss) recognized in income — ineffective portion		$	—

 

We expect minimal gain or loss to be reclassified into earnings within the next 12 months.

 

Note 8 — 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.

 

In accordance with ASC 260-10-45, Share-Based Payment Arrangements and Participating Securities and the Two-Class Method, the Company’s unvested restricted stock awards are deemed participating securities since these shares are entitled to participate in dividends declared on common shares.  During periods of net income, the calculation of earnings per share for common stock excludes  income attributable to unvested restricted stock awards from the numerator and excludes the dilutive impact of those shares from the denominator.  During periods of net loss, no effect is given to the participating securities because they do not share in the losses of the Company.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

 

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, 2011 and 2010.

 

		Three Months Ended
		August 31,
		2011			2010
Basic EPS:
Income from continuing operations		$	16,963		$	14,047
Less income attributable to participating shares		(596		)	—
Income from continuing operations available to common shareholders		16,367			14,047
Loss from discontinued operations		(314		)	(373		)
Net income attributable to AAR available to common shareholders		$	16,053		$	13,674
Basic shares:
Weighted average common shares outstanding		38,869			38,411
Earnings per share — basic:
Earnings from continuing operations		$	0.42		$	0.37
Loss from discontinued operations, net of tax		(0.01		)	(0.01		)
Earnings per share — basic		$	0.41		$	0.36
Diluted EPS:
Income from continuing operations		$	16,963		$	14,047
Less income attributable to participating shares		(548		)	—
Add after-tax interest on convertible debt		1,461			1,371
Income from continuing operations available to common shareholders		17,876			15,418
Loss from discontinued operations		(314		)	(373		)
Net income attributable to AAR available to common shareholders		$	17,562		$	15,045
Diluted shares:
Weighted average common shares outstanding		38,869			38,411
Additional shares from the assumed exercise of stock options		387			85
Additional shares from the assumed conversion of convertible debt		4,090			4,068
Weighted average common shares outstanding — diluted		43,346			42,564
Earnings per share — diluted:
Earnings from continuing operations		$	0.41		$	0.36
Loss from discontinued operations, net of tax		—			(0.01		)
Earnings per share — diluted		$	0.41		$	0.35

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

 

At August 31, 2011 and 2010, respectively, stock options to purchase 210,000 and 1,232,000 shares of common stock were outstanding, but were not included in the computation of diluted earnings 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 9 — License Fees

 

In June 2011, we entered into a ten-year agreement with Unison Industries to be the exclusive worldwide aftermarket distributor for Unison’s electrical components, sensors, switches and other systems for aircraft and industrial uses (the “Agreement”).  The Agreement is expected to generate approximately $600,000 in revenues for the Company over its ten-year term.  In connection with the agreement, we agreed to pay Unison Industries $20,000 for the exclusive distribution rights with $7,000 paid in June 2011, and $1,300 payable by January 31 of each calendar year beginning in January 2012 through 2021.

 

In June 2011, we recorded an asset of $16,513, representing the $7,000 license fee paid in June 2011 and the present value of the future obligation for the license fees under the Agreement.  This item is included in Other assets on the condensed consolidated balance sheet and is being amortized over a ten-year period.  The current portion of the deferred payments is recorded in Accrued liabilities and the long-term portion is included in Other liabilities and deferred income on the condensed consolidated balance sheet.

 

Note 10 —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.

 

Aircraft Owned through Joint Ventures

 

As of August 31, 2011, the Company had ownership interests in 22 aircraft with joint venture partners.  As of August 31, 2011, our equity investment in the 22 aircraft owned with joint venture partners was approximately $35,789 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, 2011 and 2010, we were paid $165 and $212, 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 condensed consolidated statements of cash flows based upon an evaluation of the specific facts and circumstances of each distribution.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

 

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

 

		Three Months Ended
		August 31,
		2011			2010
Sales		$	9,490		$	12,266
Income before provision for income taxes		587			254

 

		August 31,			May 31,
		2011			2011
Balance sheet information:
Assets		$	192,281		$	219,810
Debt		109,441			127,037
Members’ capital		80,182			89,375

 

Wholly-Owned Aircraft

 

In addition to the aircraft owned with joint venture partners, we own four aircraft for our own account that are considered wholly-owned.  Our investment in the four wholly-owned aircraft, after consideration of financing, is comprised of the following components:

 

		August 31,			May 31,
		2011			2011
Gross carrying value		$	26,553		$	44,586
Debt		(13,378		)	(14,072		)
Capital lease obligation		(6,249		)	(6,716		)
Net AAR investment		$	6,926		$	23,798

 

Information relating to aircraft type, year of manufacture, lessee, lease expiration date and expected disposition upon lease expiration for the 22 aircraft owned with joint venture partners and four 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
1		737-300		1987		Available		—		Re-lease/Disassemble
2		767-300		1991		United Airlines		2016 and 2017		Re-lease
1		737-300		1997		Small Planet Airlines		2013		Re-lease
1		737-400		1993		Available		—		Sale
17		737-400		1992-1997		Malaysia Airlines		Various(1)		Sale/Re-lease
22

 

(1)  9 aircraft in 2012; 4 aircraft in 2013 and 4 aircraft in 2014

 

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