AAR CORP - Quarter Report: 2017 February (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 February 28, 2017

 

or

 

¨         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.

 

Large accelerated filer  x     Accelerated filer  o     Non-accelerated filer  o    Smaller reporting company o

 

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 February 28, 2017, there were 34,324,151 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 February 28, 2017

Table of Contents

 

		Page
Part I – FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets	3
	Condensed Consolidated Statements of Income	5
	Condensed Consolidated Statements of Comprehensive Income	6
	Condensed Consolidated Statements of Cash Flows	7
	Condensed Consolidated Statement of Changes in Equity	8
	Notes to Condensed Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23
Item 4.	Controls and Procedures	23
Part II – OTHER INFORMATION
Item 1.	Legal Proceedings	24
Item 1A.	Risk Factors	24
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	24
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 February 28, 2017 and May 31, 2016

(In millions, except share data)

 

ASSETS

 

		February 28,			May 31,
		2017			2016
		(Unaudited)
Current assets:
Cash and cash equivalents		$	10.1		$	31.2
Accounts receivable, less allowances of $5.3 and $3.9, respectively		264.6			248.3
Inventories		465.6			452.0
Rotable spares and equipment on or available for short-term lease		124.8			118.3
Deposits, prepaids and other		28.0			31.9
Total current assets		893.1			881.7
Property, plant and equipment, net of accumulated depreciation of $437.1 and $437.7, respectively		211.9			238.1
Other assets:
Goodwill		114.6			117.3
Intangible assets, net of accumulated amortization of $28.4 and $26.5, respectively		30.7			35.8
Equipment on or available for long-term lease		148.6			81.1
Investment in joint ventures		12.7			15.0
Other		90.5			87.0
		397.1			336.2
		$	1,502.1		$	1,456.0

 

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 February 28, 2017 and May 31, 2016

(In millions, except share data)

 

LIABILITIES AND EQUITY

 

		February 28,			May 31,
		2017			2016
		(Unaudited)
Current liabilities:
Current maturities of long-term debt		$	2.0		$	12.0
Accounts and trade notes payable		194.6			166.3
Accrued liabilities		146.2			163.1
Total current liabilities		342.8			341.4
Long-term debt, less current maturities		168.7			136.1
Deferred tax liabilities		28.7			34.3
Other liabilities and deferred income		76.2			78.4
		273.6			248.8
Equity:
Preferred stock, $1.00 par value, authorized 250,000 shares; none issued		—			—
Common stock, $1.00 par value, authorized 100,000,000 shares; issued 45,169,677 and 44,867,703 shares at cost, respectively		45.2			44.9
Capital surplus		457.3			451.3
Retained earnings		709.2			681.6
Treasury stock, 10,845,526 and 10,353,153 shares at cost, respectively		(279.6		)	(267.6		)
Accumulated other comprehensive loss		(46.4		)	(44.4		)
Total equity		885.7			865.8
		$	1,502.1		$	1,456.0

 

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 and Nine Months Ended February 28, 2017 and February 29, 2016

(Unaudited)

(In millions, except share data)

 

		Three Months Ended						Nine Months Ended
		February 28/29,						February 28/29,
		2017			2016			2017			2016
Sales:
Sales from products		$	243.3		$	228.7		$	688.5		$	684.8
Sales from services		203.4			183.4			586.8			545.5
		446.7			412.1			1,275.3			1,230.3
Cost and operating expenses:
Cost of products		203.5			189.8			580.3			576.2
Cost of services		174.2			163.0			498.3			481.8
Selling, general and administrative		47.4			43.1			138.5			126.2
		425.1			395.9			1,217.1			1,184.2
Loss from joint ventures		(0.2		)	—			(0.2		)	(0.4		)
Operating income		21.4			16.2			58.0			45.7
Loss on extinguishment of debt		—			—			—			(0.4		)
Interest expense		(1.5		)	(1.7		)	(4.0		)	(5.2		)
Interest income		0.1			0.1			0.2			0.2
Income from continuing operations before provision for income taxes		20.0			14.6			54.2			40.3
Provision for income taxes		6.9			4.7			19.1			13.8
Income from continuing operations		13.1			9.9			35.1			26.5
Discontinued operations:
Operating loss		(0.1		)	(1.3		)	(0.7		)	(7.3		)
Gain from contingent consideration		—			—			—			27.7
Provision for income taxes (benefit)		(0.7		)	3.8			(0.9		)	11.2
Income (Loss) from discontinued operations		0.6			(5.1		)	0.2			9.2
Net income		$	13.7		$	4.8		$	35.3		$	35.7
Earnings per share — basic:
Earnings from continuing operations		$	0.39		$	0.29		$	1.03		$	0.76
Earnings (Loss) from discontinued operations		0.02			(0.15		)	0.01			0.27
Earnings per share — basic		$	0.41		$	0.14		$	1.04		$	1.03
Earnings per share — diluted:
Earnings from continuing operations		$	0.38		$	0.29		$	1.02		$	0.76
Earnings (Loss) from discontinued operations		0.02			(0.15		)	0.01			0.27
Earnings per share — diluted		$	0.40		$	0.14		$	1.03		$	1.03

 

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 Comprehensive Income

For the Three and Nine Months Ended February 28, 2017 and February 29, 2016

(Unaudited)

(In millions)

 

		Three Months Ended						Nine Months Ended
		February 28/29,						February 28/29,
		2017			2016			2017			2016
Net income		$	13.7		$	4.8		$	35.3		$	35.7
Other comprehensive income (loss), net of tax expense (benefit):
Currency translation adjustments		(0.2		)	(1.8		)	(2.8		)	(0.8		)
Pension and other post-retirement plans:
Amortization of actuarial loss and prior service cost included in net income, net of tax of $0.2 and $0.1 for the three months ended February 28, 2017 and February 29, 2016, respectively, and $0.5 and $0.4 for the nine months ended February 28, 2017 and February 29, 2016, respectively		0.3			0.3			0.8			0.8
Other comprehensive income (loss), net of tax		0.1			(1.5		)	(2.0		)	—
Comprehensive income		$	13.8		$	3.3		$	33.3		$	35.7

 

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 Nine Months Ended February 28, 2017 and February 29, 2016

(Unaudited)

(In millions)

 

		Nine Months Ended
		February 28/29,
		2017			2016
Cash flows provided from (used in) operating activities:
Net income		$	35.3		$	35.7
Less: Income from discontinued operations		(0.2		)	(9.2		)
Income from continuing operations		35.1			26.5
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and intangible amortization		39.0			37.8
Amortization of stock-based compensation		7.6			6.2
Amortization of overhaul costs		14.5			16.3
Deferred tax provision (benefit)		(1.7		)	7.5
Gain on sale of product line		(2.6		)	—
Changes in certain assets and liabilities:
Accounts receivable		(17.8		)	(24.0		)
Inventories		(12.0		)	(38.5		)
Rotable spares and equipment on or available for short-term lease		(4.9		)	(8.3		)
Equipment on or available for long-term lease		(75.7		)	(7.7		)
Accounts and trade notes payable		31.8			19.8
Accrued and other liabilities		(13.3		)	(32.9		)
Other, primarily program and overhaul costs		(9.6		)	(15.5		)
Net cash used in operating activities — continuing operations		(9.6		)	(12.8		)
Net cash used in operating activities — discontinued operations		(1.6		)	(1.1		)
Net cash used in operating activities		(11.2		)	(13.9		)
Cash flows provided from (used in) investing activities:
Property, plant and equipment expenditures		(28.0		)	(74.6		)
Proceeds from asset disposals		18.0			6.5
Proceeds from sale-leaseback		—			38.5
Payment for acquisition					(4.8		)
Other		(2.8		)	1.1
Net cash used in investing activities — continuing operations		(12.8		)	(33.3		)
Net cash provided from investing activities — discontinued operations		—			27.3
Net cash used in investing activities		(12.8		)	(6.0		)
Cash flows provided from financing activities:
Short-term borrowings (repayments), net		34.0			85.0
Reduction in long-term borrowings		(10.0		)	(44.9		)
Cash dividends		(7.7		)	(7.8		)
Purchase of treasury stock		(16.6		)	(17.4		)
Stock option exercises		5.3			1.5
Other		(1.6		)	(0.4		)
Net cash provided from financing activities — continuing operations		3.4			16.0
Effect of exchange rate changes on cash		(0.5		)	(0.4		)
Decrease in cash and cash equivalents		(21.1		)	(4.3		)
Cash and cash equivalents, beginning of period		31.2			54.7
Cash and cash equivalents, end of period		$	10.1		$	50.4

 

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 Changes in Equity

For the Nine Months Ended February 28, 2017

(Unaudited)

(In millions)

 

														Accumulated
														Other
		Common			Capital			Retained			Treasury			Comprehensive
		Stock			Surplus			Earnings			Stock			Loss			Total Equity
Balance, May 31, 2016		$	44.9		$	451.3		$	681.6		$	(267.6	)	$	(44.4	)	$	865.8
Net income		—			—			35.3			—			—			35.3
Cash dividends		—			—			(7.7		)	—			—			(7.7		)
Stock option activity		—			2.0			—			5.9			—			7.9
Restricted stock activity		0.3			4.0			—			(1.3		)	—			3.0
Repurchase of shares		—			—			—			(16.6		)	—			(16.6		)
Other comprehensive loss, net of tax		—			—			—			—			(2.0		)	(2.0		)
Balance, February 28, 2017		$	45.2		$	457.3		$	709.2		$	(279.6	)	$	(46.4	)	$	885.7

 

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

February 28, 2017

(Unaudited)

(Dollars in millions, 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, 2016 has been derived from audited financial statements.  To prepare the financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”), 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 GAAP, 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 February 28, 2017, the Condensed Consolidated Statements of Income and the Condensed Consolidated Statements of Comprehensive Income for the three and nine month periods ended February 28, 2017 and February 29, 2016, the Condensed Consolidated Statements of Cash Flows for the nine-month periods ended February 28, 2017 and February 29, 2016, and the Condensed Consolidated Statement of Changes in Equity for the nine month period ended February 28, 2017.  The results of operations for such interim periods are not necessarily indicative of the results for the full year.

 

New Accounting Pronouncements

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which provides guidance for revenue recognition.  This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets.  This ASU will supersede the revenue recognition requirements in ASC 605, Revenue Recognition, and most industry-specific guidance.  This ASU will also supersede certain cost guidance included in Subtopic 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts.  In August 2015, the FASB issued ASU No. 2015-14 which deferred the effective date of the new standard by one year which will make the new standard effective for us beginning June 1, 2018.  The ASU may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of initial application.  We continue to gain an understanding of the standard’s revenue recognition model and are in the process of analyzing and documenting our significant customer contracts to evaluate the potential impact of the adoption of this new standard on our consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases.  This ASU amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets, including those classified as operating leases under the current accounting guidance.  In addition, this ASU will require new qualitative and quantitative disclosures about the Company’s leasing activities.  This new standard will be effective for us beginning June 1, 2019 with early adoption permitted.  This ASU requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief.  We are currently evaluating the impact of the adoption of this new standard on our consolidated financial statements.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2017

(Unaudited)

(Dollars in millions, except per share amounts)

 

Note 2 — Discontinued Operations

 

On March 26, 2015, we completed the sale of our Telair Cargo Group to TransDigm, Inc.  The Telair Cargo Group was comprised of Telair International, Telair US, and Nordisk Aviation Products.  Cash received at closing in the fourth quarter of fiscal 2015 before fees and expenses was $705 million.  The sale also allowed for contingent consideration of up to $35 million based on the occurrence of certain post-closing events related to the A400M cargo system.  We recognized a pre-tax gain on the sale (net of transaction expenses and fees) of $198.6 million in the fourth quarter of fiscal 2015.

 

In the first quarter of fiscal 2016, we recognized a gain of $27.7 million net of expenses representing the resolution of the contingent consideration related to the A400M cargo system.

 

During fiscal 2015, we also announced our intention to sell our Precision Systems Manufacturing (“PSM”) businesses comprised of our metal and composite machined and fabricated parts manufacturing operations.  We recognized impairment charges of $57.5 million during fiscal 2015 to reduce the carrying value of the PSM business’s net assets to their expected value at the time of sale.

 

During the first quarter of fiscal 2017, we decided to retain our composite manufacturing operations within our Expeditionary Services segment as a product line within our mobility products business.  As a result, we reclassified our composite manufacturing operations into continuing operations for all periods presented.  Also during the first quarter of fiscal 2017, we decided to shut down the metal machining operation which had been available for sale.  The shutdown of the metal machining operation was completed prior to the end of the first quarter.

 

Telair Cargo Group and PSM’s metal machining operation are reported as discontinued operations in the Condensed Consolidated Statements of Income for all periods presented.  No amounts for general corporate overhead or interest expense were allocated to discontinued operations during the periods presented.

 

Assets of discontinued operations of $0.1 million and $4.0 million at February 28, 2017 and May 31, 2016, respectively, were classified as Deposits, prepaids, and other on the Condensed Consolidated Balance Sheet.  Liabilities of discontinued operations of $7.7 million and $12.5 million at February 28, 2017 and May 31, 2016, respectively, were classified as Accrued Liabilities on the Condensed Consolidated Balance Sheet.  Operating income from discontinued operations for the three and nine month periods ended February 28, 2017 and February 29, 2016 was comprised of the following:

 

		Three Months Ended						Nine Months Ended
		February 28/29,						February 28/29,
		2017			2016			2017			2016
Sales		$	—		$	3.5		$	0.6		$	8.6
Cost of sales		—			(3.8		)	(1.0		)	(13.0		)
Selling, general and administrative expenses		(0.1		)	(1.0		)	(0.3		)	(2.9		)
Operating loss from discontinued operations		$	(0.1	)	$	(1.3	)	$	(0.7	)	$	(7.3	)

 

Unless otherwise noted, amounts and disclosures throughout these Notes to Condensed Consolidated Financial Statements relate to our continuing operations.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2017

(Unaudited)

(Dollars in millions, except per share amounts)

 

Note 3 — Revenue Recognition

 

Sales and related cost of sales for product sales are recognized upon shipment of the product to the customer.  Our standard terms and conditions provide that title passes to the customer when the product is shipped to the customer.  Sales of certain defense products are recognized upon customer acceptance, which includes transfer of title.  Under the majority of our expeditionary airlift services contracts, we are paid and record as revenue a fixed daily amount per aircraft for each day an aircraft is available to perform airlift services.  In addition, we are paid and record as revenue an amount which is based on number of hours flown.  Sales from services and the related cost of services are generally recognized when customer-owned material is shipped back to the customer.  We have adopted this accounting policy because at the time the customer-owned material is shipped back to the customer, all services related to that material are complete as our service agreements generally do not require us to provide services at customer sites.  Furthermore, serviced units are typically shipped to the customer immediately upon completion of the related services.  Sales and related cost of sales for certain large airframe maintenance contracts and performance-based logistics programs are recognized by the percentage of completion method, based on the relationship of costs incurred to date to the estimated total costs.  When our experience and projections indicate adjustments to the estimated margin are required, changes are recognized using the cumulative catch-up method with the impact of the change from inception to date recorded in the current period.  We recognized favorable cumulative catch-up adjustments of $2.9 million and $2.5 million during the three month periods ended February 28, 2017 and February 29, 2016, respectively, and $6.7 million and $6.0 million during the nine month periods ended February 28, 2017 and February 29, 2016, respectively.

 

Lease revenues are recognized as earned.  Income from monthly or quarterly rental payments is recorded in the pertinent period according to the lease agreement.  However, for leases that provide variable rents, we recognize lease income on a straight-line basis.  In addition to a monthly lease rate, some engine leases require an additional rental amount based on the number of hours the engine is used in a particular month.  Lease income associated with these contingent rentals is recorded in the period in which actual usage is reported to us by the lessee, which is normally the month following the actual usage.

 

Certain supply chain management programs we provide to our customers contain multiple elements or deliverables, such as program and warehouse management, parts distribution, and maintenance and repair services.  We recognize revenue for each element or deliverable that can be identified as a separate unit of accounting at the time of delivery based upon the relative fair value of the products and services.

 

In June 2016, the U.S. Air Force awarded the new contract for the KC-10 Extender Contractor Logistics Support Program (“KC-10 Program”) to a competitor.  Our principal services under the prior contract for the KC-10 Program were completed in January 2017; however, we expect limited services will continue for an unspecified period of time.  Fiscal 2016 revenue and gross profit for the KC-10 Program was $148.1 million and $16.0 million, respectively, while average annual revenue and gross profit recognized over the last three fiscal years was $115.9 million and $7.4 million, respectively.

 

Included in accounts receivable as of February 28, 2017 and May 31, 2016, are $16.9 million and $29.8 million, respectively, of unbilled accounts receivable related to the KC-10 Program.  These unbilled accounts receivable relate to costs we have incurred on parts that were requested and accepted by our customer to support the KC-10 Program.  These costs have not been billed by us because the customer has not issued the final paperwork necessary to allow for billing.

 

Note 4 — Accounting for Stock-Based Compensation

 

Restricted Stock

 

In the three month period ended August 31, 2016, as part of our annual long-term stock incentive compensation, we granted 212,583 shares of performance-based restricted stock and 34,100 shares of time-based restricted stock to eligible employees.  The average grant date fair value per share for these shares was $24.00.  In June 2016, we also granted 50,000 shares of time-based restricted stock to members of the Board of Directors with a grant date fair value per share of $24.39.

 

Expense charged to operations for restricted stock was $1.6 million and $1.4 million during the three month periods ended February 28, 2017 and February 29, 2016, respectively, and $4.2 million and $3.6 million during the nine month periods ended February 28, 2017 and February 29, 2016, respectively.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2017

(Unaudited)

(Dollars in millions, except per share amounts)

 

Stock Options

 

The total intrinsic value of stock options exercised during the nine month periods ended February 28, 2017 and February 29, 2016 was $3.3 million and $0.9 million, respectively.   Expense charged to operations for stock options was $1.1 million and $0.9 million during the three month periods ended February 28, 2017 and February 29, 2016, respectively, and $3.4 million and $2.6 million during the nine month periods ended February 28, 2017 and February 29, 2016, respectively.

 

Note 5 — Inventory

 

The summary of inventories is as follows:

 

		February 28,			May 31,
		2017			2016
Raw materials and parts		$	41.6		$	46.3
Work-in-process		26.0			23.4
Aircraft and engine parts, components and finished goods		382.5			366.6
Aircraft held for sale and related support parts		15.5			15.7
		$	465.6		$	452.0

 

We had eight aircraft held for sale comprised of five fixed-wing and three rotary-wing aircraft at February 28, 2017 and May 31, 2016.

 

Note 6 — Aircraft Sale-Leaseback Transactions

 

During the nine-month period ended February 29, 2016, we received proceeds of $38.5 million from sale-leaseback transactions for two AW-189 rotary-wing aircraft.  The $1.7 million gain realized on the sale was deferred and is being amortized over the lease term of ten years.

 

Note 7 — Income Taxes

 

During the third quarter of 2017, we recorded a $0.7 million income tax benefit in discontinued operations related to tax provision to federal income tax return filing differences.

 

During the third quarter of fiscal 2016, we completed a reconciliation of our tax basis assets and liabilities and an analysis of our income tax payable which identified prior year immaterial errors netting to $0.2 million.  The correction of these errors was recognized in the three months ended February 29, 2016, with $1.7 million recognized as income tax expense in discontinued operations and $1.5 million recognized as income tax benefit within income from continuing operations.  We concluded these errors were not material to any prior reporting periods.

 

During the third quarter of fiscal 2016, we also recognized $2.8 million of income tax expense in discontinued operations related to changes in estimates associated with tax provision to federal income tax return filing differences.

 

Note 8 — Supplemental Cash Flow Information

 

		Nine Months Ended
		February 28/29,
		2017			2016
Interest paid		$	3.2		$	3.3
Income taxes paid		8.3			26.5
Income tax refunds received		1.2			1.3

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2017

(Unaudited)

(Dollars in millions, except per share amounts)

 

Note 9 — Financing Arrangements

 

A summary of the carrying amount of our debt is as follows:

 

		February 28,			May 31,
		2017			2016
Revolving Credit Facility expiring November 1, 2021 with interest payable monthly		$	144.0		$	110.0
Industrial revenue bond (secured by property, plant and equipment) due August 1, 2018 with interest payable monthly		25.0			25.0
Note payable due March 9, 2017 with floating interest rate, payable semi-annually on June 1 and December 1		—			10.0
Capital lease obligations		3.8			5.1
Total debt		172.8			150.1
Current maturities of debt		(2.0		)	(12.0		)
Debt issuance costs, net		(2.1		)	(2.0		)
Long-term debt		$	168.7		$	136.1

 

We maintain a Revolving Credit Facility with various financial institutions, as lenders and Bank of America, N.A., as administrative agent for the lenders which provides the Company an aggregate revolving credit commitment amount of $500 million.   The Company, under certain circumstances, may request an increase to the revolving credit commitment by an aggregate amount of up to $250 million, not to exceed $750 million in total.

 

On November 1, 2016, we entered into an amendment to our Revolving Credit Facility which extended the maturity of the Revolving Credit Facility to November 1, 2021, eliminated the condition of no material adverse charge for credit extensions and modified certain other provisions.

 

We are subject to a number of covenants under our financing arrangements, including restrictions that relate to the payment of cash dividends, maintenance of minimum net working capital and tangible net worth levels, sales of assets, additional financing, purchase of our shares and other matters.  We are in compliance with all financial and other covenants under our financing arrangements as of February 28, 2017.

 

At February 28, 2017 and May 31, 2016, our debt had a fair value that approximates the carrying value.  These debt instruments are classified as Level 3 in the fair value hierarchy which is defined as a fair value determined based upon one or more significant unobservable inputs.

 

Convertible Notes

 

During the three-month period ended August 31, 2015, we repurchased $14.4 million of our outstanding 2.25% convertible notes due March 1, 2016 for $14.6 million cash including $0.2 million of accrued interest and recognized a $0.3 million loss on the early extinguishment of the notes.  During the three-month period ended November 30, 2015, we repurchased $9.7 million of our outstanding 2.25% convertible notes due March 1, 2016 for $9.7 million cash and recognized a $0.1 million loss on the early extinguishment of the notes. On March 1, 2016, we retired the remaining balance of our 2.25% convertible notes at maturity for $26.0 million cash, including accrued interest of $0.3 million.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2017

(Unaudited)

(Dollars in millions, except per share amounts)

 

Note 10 — 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 and shares issuable upon vesting of restricted stock awards.

 

In accordance with ASC 260-10-45, Share-Based Payment Arrangements and Participating Securities and the Two-Class Method, our 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.

 

A reconciliation of the computations of basic and diluted earnings per share information for the three and nine month periods ended February 28, 2017 and February 29, 2016 is as follows:

 

		Three Months Ended						Nine Months Ended
		February 28/29,						February 28/29,
		2017			2016			2017			2016
Basic and Diluted EPS:
Income from continuing operations		$	13.1		$	9.9		$	35.1		$	26.5
Less income attributable to participating shares		(0.1		)	(0.1		)	(0.3		)	(0.3		)
Income from continuing operations attributable to common shareholders		13.0			9.8			34.8			26.2
Income (Loss) from discontinued operations attributable to common shareholders		0.6			(5.1		)	0.2			9.2
Net income attributable to common shareholders for earnings per share		$	13.6		$	4.7		$	35.0		$	35.4
Weighted Average Shares:
Weighted average common shares outstanding — basic		33.7			34.2			33.9			34.5
Additional shares from the assumed exercise of stock options		0.5			0.2			0.4			0.2
Weighted average common shares outstanding — diluted		34.2			34.4			34.3			34.7
Earnings per share — basic:
Earnings from continuing operations		$	0.39		$	0.29		$	1.03		$	0.76
Earnings (Loss) from discontinued operations		0.02			(0.15		)	0.01			0.27
Earnings per share — basic		$	0.41		$	0.14		$	1.04		$	1.03
Earnings per share — diluted:
Earnings from continuing operations		$	0.38		$	0.29		$	1.02		$	0.76
Earnings (Loss) from discontinued operations		0.02			(0.15		)	0.01			0.27
Earnings per share — diluted		$	0.40		$	0.14		$	1.03		$	1.03

 

At February 29, 2016 stock options to purchase 178,490 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 period then ended.  The average market price of our common shares during the interim period ended February 28, 2017 was greater than the exercise prices of our outstanding stock options.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2017

(Unaudited)

(Dollars in millions, except per share amounts)

 

Note 11 — Accumulated Other Comprehensive Loss

 

Changes in our accumulated other comprehensive loss (“AOCL”) by component for the three and nine month periods ended February 28, 2017 and February 29, 2016 were as follows:

 

		Currency Translation Adjustments			Pension Plans			Total
Balance at December 1, 2016		$	(3.7	)	$	(42.8	)	$	(46.5	)
Other comprehensive loss before reclassifications		(0.2		)	—			(0.2		)
Amounts reclassified from AOCL		—			0.3			0.3
Total other comprehensive income (loss)		(0.2		)	0.3			0.1
Balance at February 28, 2017		$	(3.9	)	$	(42.5	)	$	(46.4	)
Balance at December 1, 2015		$	(0.1	)	$	(38.8	)	$	(38.9	)
Other comprehensive income before reclassifications		(1.8		)	—			(1.8		)
Amounts reclassified from AOCL		—			0.3			0.3
Total other comprehensive income		(1.8		)	0.3			(1.5		)
Balance at February 29, 2016		$	(1.9	)	$	(38.5	)	$	(40.4	)

 

		Currency Translation Adjustments			Pension Plans			Total
Balance at June 1, 2016		$	(1.1	)	$	(43.3	)	$	(44.4	)
Other comprehensive loss before reclassifications from AOCL		(2.8		)	—			(2.8		)
Amounts reclassified from AOCL		—			0.8			0.8
Total other comprehensive income (loss)		(2.8		)	0.8			(2.0		)
Balance at February 28, 2017		$	(3.9	)	$	(42.5	)	$	(46.4	)
Balance at June 1, 2015		$	0.9		$	(41.3	)	$	(40.4	)
Reclassification within AOCL		(2.0		)	2.0			—
Other comprehensive income before reclassifications		(0.8		)	—			(0.8		)
Amounts reclassified from AOCL		—			0.8			0.8
Total other comprehensive income		(0.8		)	0.8			—
Balance at February 29, 2016		$	(1.9	)	$	(38.5	)	$	(40.4	)

 

Note 12 — Sale of Product Line

 

During the first quarter of fiscal 2017, we sold certain assets related to our temperature-controlled container product line to Sonoco Protective Solutions, Inc. (“Sonoco”) for $5 million.  The sale price included $3 million paid at closing and $2 million in non-contingent, deferred consideration due over the next two years.  We recognized a gain of $2.6 million on the sale.  In conjunction with the sale, we also entered into a long-term manufacturing agreement to supply temperature-controlled containers to Sonoco over the next three years.

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2017

(Unaudited)

(Dollars in millions, except per share amounts)

 

Note 13 — Business Segment Information

 

Consistent with how our chief operating decision making officer (Chief Executive Officer) evaluates performance and the way we are organized internally, we report our activities in two business segments:  Aviation Services comprised of supply chain and maintenance, repair and overhaul (“MRO”) activities and Expeditionary Services comprised of airlift and mobility activities.

 

The Aviation Services segment consists of businesses that provide spares and maintenance support for aircraft operated by our commercial and government/defense customers.  Sales in the Aviation Services segment are derived from the sale and lease of a wide variety of new, overhauled and repaired engine and airframe parts and components to the commercial aviation and government and defense markets.  We provide customized inventory supply chain management, performance based logistics programs, aircraft component repair management services, and aircraft modifications.  The segment also includes repair, maintenance and overhaul of aircraft, landing gear and components.  We also sell and lease used commercial aircraft through joint venture arrangements.  Cost of sales consists principally of the cost of product, direct labor, and overhead.

 

The Expeditionary Services segment consists of businesses that provide products and services supporting the movement of equipment and personnel by the U.S. Department of Defense (“DoD”), foreign governments and non-governmental organizations.  Sales in the Expeditionary Services segment are derived from the delivery of airlift services to mostly government and defense customers and the design and manufacture of pallets, shelters, and containers used to support the U.S. military’s requirements for a mobile and agile force.  We also provide system integration services for specialized command and control systems and composite manufacturing.  Cost of sales consists principally of aircraft maintenance costs, depreciation, the cost of material to manufacture products, 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, 2016.  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.  Gross profit is calculated by subtracting cost of sales from sales.  The assets and certain expenses related to corporate activities are not allocated to the segments.  Our reportable segments are aligned principally around differences in products and services.

 

Selected financial information for each segment is as follows:

 

		Three Months Ended						Nine Months Ended
		February 28/29,						February 28/29,
		2017			2016			2017			2016
Sales:
Aviation Services		$	382.8		$	349.2		$	1,064.1		$	1,024.6
Expeditionary Services		63.9			62.9			211.2			205.7
		$	446.7		$	412.1		$	1,275.3		$	1,230.3

 

		Three Months Ended						Nine Months Ended
		February 28/29,						February 28/29,
		2017			2016			2017			2016
Gross profit:
Aviation Services		$	63.4		$	58.6		$	172.8		$	166.7
Expeditionary Services		5.6			0.7			23.9			5.6
		$	69.0		$	59.3		$	196.7		$	172.3

 

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2017

(Unaudited)

(Dollars in millions, except per share amounts)

 

The following table reconciles segment gross profit to consolidated income before provision for income taxes.

 

 

		Three Months Ended						Nine Months Ended
		February 28/29,						February 28/29,
		2017			2016			2017			2016
Segment gross profit		$	69.0		$	59.3		$	196.7		$	172.3
Selling, general and administrative		(47.4		)	(43.1		)	(138.5		)	(126.2		)
Loss from joint ventures		(0.2		)	—			(0.2		)	(0.4		)
Loss on extinguishment of debt		—			—			—			(0.4		)
Interest expense		(1.5		)	(1.7		)	(4.0		)	(5.2		)
Interest income		0.1			0.1			0.2			0.2
Income before provision for income taxes		$	20.0		$	14.6		$	54.2		$	40.3

 

Note 14 — Legal Proceedings

 

We are not a party to any material pending legal proceeding (including any governmental or environmental proceeding) other than routine litigation incidental to our business except for the following:

 

DynCorp International LLC v. AAR Airlift Group, Inc.

 

On November 5, 2015, AAR Airlift Group, Inc.  (“AAR Airlift”), a wholly-owned subsidiary of AAR CORP. filed with the United States District Court for the Middle District of Florida (the “District Court”) a motion to dismiss a First Amended Complaint filed by DynCorp International LLC (“DynCorp”) alleging that AAR Airlift misappropriated DynCorp’s trade secrets in connection with the submission of proposals pursuant to the solicitation issued by the Department of State Bureau of International Narcotics and Law Enforcement Affairs, Office of Aviation (“INL/A”) in support of the Global Aviation Support Services (“GASS”) program which was subsequently awarded to AAR Airlift on September 1, 2016.

 

On January 14, 2016, the District Court granted AAR Airlift’s motion to dismiss the First Amended Complaint.  On February 2, 2016, DynCorp filed an appeal to the United States Court of Appeals for the Eleventh Circuit (the “Court of Appeals”) with respect to the District Court’s order on the motion to dismiss and other orders issued by the District Court in this case.

 

On November 21, 2016, the Court of Appeals reversed the District Court’s dismissal of the amended complaint and remanded the case to the District Court for further proceedings.  The District Court has set a discovery schedule that ends September 1, 2017 and a trial date of April 2, 2018.

 

AAR Airlift will continue to defend itself vigorously against DynCorp’s lawsuit, which it believes is entirely without merit.

 

17