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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549


FORM 10-K

(Mark One)

ýx

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934


For the fiscal year ended May 31, 20042007


or

o


 


Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934


For the transition period from                        to                         

For the transition period from            to           

Commission file number 1-6263

AAR CORP.
(Exact name of Registrantregistrant as specified in its charter)


Delaware



36-2334820

(State or other jurisdiction of
incorporation or organization)

(I.R.S. Employer Identification No.)

incorporation or organization)

One AAR Place, 1100 N. Wood Dale Road, Wood Dale, Illinois 60191
(Address of principal executive offices, including zip code)

Registrant's

Registrant’s telephone number, including area code:(630) 227-2000

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class


 


Name of Each Exchange on Which Registered

Common Stock, $1.00 par value

New York Stock Exchange

Chicago Stock Exchange


Common Stock Purchase Rights


 


New York Stock Exchange

Chicago Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes
xNone No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.
Yes
o No x

Indicate by check mark whether the Registrantregistrant (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 Registrantregistrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yesý Noox

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant'sregistrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.ýo

Indicate by check mark whether the Registrantregistrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): 

Large accelerated filer x          Accelerated filer o          Non-Accelerated filer o

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

At November 28, 2003,30, 2006, the aggregate market value of the Registrant'sregistrant’s voting stock held by nonaffiliates was approximately $301,972,993$955,063,050 (based upon the closing price of the Common Stock at November 28, 200330, 2006 as reported on the New York Stock Exchange). The calculation of such market value has been made for the purposes of this report only and should not be considered as an admission or conclusion by the Registrant that any person is in fact an affiliate of the Registrant.

On July 1, 2004,June 30, 2007, there were 32,243,86837,795,630 shares of Common Stock outstanding.

Documents Incorporated by Reference

Portions of the definitive proxy statement relating to the Registrant's 2004registrant’s 2007 Annual Meeting of Stockholders, to be held October 13, 2004,17, 2007 are incorporated by reference in Part III to the extent described therein.III.







TABLE OF CONTENTS




PART I

ITEM 1.                BUSINESS
(Dollars in thousands)
PART I

GeneralITEM 1.    BUSINESS (Dollars in thousands)

General

AAR CORP. and its subsidiaries are referred to herein collectively as "AAR," "Company," "we," "us,"“AAR,” “Company,” “we,” “us,” and "our"“our” unless the context indicates otherwise. We wereAAR was founded in 1951, organized in 1955 and were reincorporated in Delaware in 1966. We are a leading independentdiversified provider of products and services to the worldwide aviation/aerospace industry. We also marketaviation and sell certain of our products and services to the U.S. Government, including various branches and agencies within the U.S. Military and their contractors.defense industries. We conduct our business activities primarily through fivesix principal operating subsidiaries: AAR Parts Trading, Inc., AAR Aircraft & Engine Sales & Leasing, Inc., AAR Services, Inc., AAR Aircraft Services, Inc., AAR Manufacturing, Inc., and AAR International, Inc. Our international business activities are conducted primarily through AAR International, Inc.

We report our activities in four business segments: (i) Inventory and Logistic Services,Aviation Supply Chain, comprised primarily of business activities conducted through AAR Parts Trading, Inc. and, AAR Services, Inc., (ii) Maintenance, Repair and Overhaul, comprised primarily of business activities conducted through AAR Engine Services, Inc. and AAR Allen Services, Inc., a wholly-owned subsidiariessubsidiary of AAR Parts Trading, Inc. and AAR Services, Inc., respectively, and AAR International, Inc. (ii) Maintenance, Repair and Overhaul, comprised primarily of business activities conducted through AAR Services, Inc., AAR Allen Services, Inc. and AAR Aircraft Services, Inc. (iii) Manufacturing,Structures and Systems, comprised primarily of business activities conducted through AAR Manufacturing, Inc., and (iv) Aircraft and Engine Sales and Leasing, comprised of business activities primarily conducted through AAR Aircraft & Engine Sales & Leasing, Inc.

Inventory and Logistic ServicesAviation Supply Chain

Activities in our Inventory and Logistic ServicesAviation Supply Chain segment include the purchase and sale of a wide variety of new, overhauled and repaired engine and airframe parts and components for the aviation aftermarketour airline and militarydefense customers. We also repair and overhaul a wide variety of avionics, electrical, electronic, fuel, hydraulic and pneumatic components and instruments and a broad range of internal airframe components for the same customer categories. We provide customized inventory supply and management programs and performance-based logistics programs for engine and airframe parts and components in support of customerairline and defense customer’s maintenance activities. The types of services provided under these programs include program and warehouse management, parts replenishment and parts and component repair and overhaul. We are an authorized distributor for more than 125 leading aviation and aerospace product manufacturers. In addition, we sell and lease commercial jet engines. We acquire aviation productsparts and components for the Inventory and Logistic ServicesAviation Supply Chain segment from domestic and foreign airlines, original equipment manufacturers, independent aviation service companies and aircraft leasing companies and original equipment manufacturers.companies. In the Inventory and Logistic ServicesAviation Supply Chain segment, the majority of our sales are made pursuant to standard commercial purchase orders. In certain inventory supply and management programs and performance-based logistics programs, we supply products and services under agreements reflecting negotiated terms and conditions.

Maintenance, Repair and Overhaul

Activities in our Maintenance, Repair and Overhaul segment include airframe maintenance services and the maintenance, repair and overhaul and exchange of a wide varietymost types of airframe and engine parts and componentslanding gear for our commercialairline and militarydefense customers. RepairWe have a long-term lease to occupy a portion of an airframe maintenance facility in Indianapolis, Indiana (the Indianapolis Maintenance Center or IMC), which is owned by the Indianapolis Airport Authority (IAA). We believe the IMC is one of the most efficient and overhaul capabilities include most commercial aircraft landing gear,state-of-the-art airframe maintenance facilities in the world and our occupancy of the IMC significantly expands our maintenance and repair capacity and capabilities. The IMC is comprised of 12 airframe maintenance bays, backshop space to support airframe maintenance activities, warehouse and office space. At May 31, 2007, we occupied and were performing maintenance activities in seven bays and occupied certain office space within the IMC. We have options for


three additional bays and additional office space under a wide variety of avionics, instruments, electrical, electronic, fuel, hydrauliclease which expires in December 2014, with a ten-year renewal option. The lease agreement contains early termination rights for AAR and pneumatic components and a broad range of internal airframe components. We alsothe IAA, which may be exercised in specified circumstances. In addition to the IMC, we operate an aircraft maintenance facility located in Oklahoma City, Oklahoma providing airframe maintenance, modification, special equipment installation, painting services and aircraft terminal services for various models of commercial, military,defense, regional, business and general aviation aircraft. On January 12, 2007, we acquired substantially all the assets of Reebaire Aircraft, Inc. (“Reebaire”), a regional airframe maintenance and repair overhaul facility located in Hot Springs, Arkansas. This acquisition increases our regional MRO capacity in North America. The purchase price was approximately $11,800 and was paid in cash. We also operate an aircraft storage facility. In June 2004, we entered into a long-term lease to occupy a portion of an airframe maintenance facility in Indianapolis, Indiana, significantly expanding our maintenance and repair capacity and capabilities. The repair and overhaul of parts and components also support inventory management activities within the Inventory and Logistic Services segment. We also provide turbine engine overhaul and parts supply services to industrial gas and steam turbine operators. In this segment, in addition to sales made under standard commercial purchase orders, a portion of the segment's sales occur



pursuant to contracts under which we agree to maintain, repair and overhaul parts, components and whole aircraft.Roswell, New Mexico. In this segment, we purchase replacement parts from original equipment manufacturers and suppliers that are used in variousour maintenance, repair and overhaul operations. We have ongoing arrangements with original equipment manufacturers (OEM)(OEMs) that provide us access to parts, repair manuals and service bulletins in support of parts manufactured by the OEM. Although the terms of each arrangement vary, they typically are made on standard OEM terms as to duration, price and delivery. When possible, we will obtain replacement parts used in repair and overhaul activities from operating units in our InventoryAviation Supply Chain segment.

Structures and Logistic Services segment.Systems

Manufacturing

Activities in our ManufacturingStructures and Systems segment include the manufacture and repair of pallets and a wide arrayvariety of containers pallets and shelters in support of military and humanitarian tactical deployment activities. On April 2, 2007, we acquired 100% of the shares of common stock of Brown International Corporation (“Brown”), a privately held defense contractor that provides engineering, design, manufacturing and systems integration services. The purchase price was approximately $26,700 and was paid in cash. We also design, manufacture and install in-plane cargo loading and handling systems for commercial and military aircraft and helicopters. We also design and manufacture advanced composite materials for commercial, business and military aircraft as well as advanced composite structures for the transportation industry. During fiscal 2007, we decided to exit our non-core industrial turbine business located in Frankfort, New York, and have treated it as a discontinued operation. In this segment, sales are made to customers pursuant to standard commercial purchase orders and contracts. InWe purchase the raw materials for this segment, we purchasebusiness, including aluminum sheets, extrusions and castings and other necessary supplies, from a number of vendors.

Aircraft and Engine Sales and Leasing

Activities in our Aircraft and Engine Sales and Leasing segment include the sale or lease of used commercial jet aircraft and the sale or lease of a wide variety of new and overhauled commercial jet engines. In this segment, eachaircraft. Each sale or lease is negotiated as a separate agreement which includes term, price, representations, warranties and lease return provisions. Leases arehave fixed in regard to term;terms; early termination by the lesseeeither party is not permitted except in the event of a breach by us.breach. In this segment, we purchase aircraft from airlines and engines from domestic and foreign airlines, aircraft and engine leasing companies and original equipment manufacturers. Activitiesfor our own account or in the Aircraft and Engine Sales and Leasing segment also include the formation and operation of joint venturespartnership with strategic andor financial partners. The primary businesspartners typically under joint venture agreements. At May 31, 2007, the total number of aircraft held in these joint ventures iswas 12. We also directly own nine aircraft outside of the ownership and lease of aircraft to commercial airlines.joint ventures. Within this segment, we also provide advisory services which consist of assistance in remarketing aircraft, and engines, records management and storage maintenance.

Raw Materials

We historically have been able to obtain raw materials and other items for our inventories for each of our segments at competitive prices, terms and conditions from numerous sources, and we expect to be able to continue to do so.


Terms of Sale

In the Inventory and Logistic Services,Aviation Supply Chain, Maintenance, Repair and Overhaul, and ManufacturingStructures and Systems segments, we generally sell our products under standard 30-day terms. On occasion, certain customers (principally foreign customers) will negotiate extended payment terms (60-90 days). Except for customary warranty provisions, customers do not have the right to return products nor do they have the right to extended financing. In the Aircraft and Engine Sales and Leasing segment, we sell our products on a cash due at delivery basis, standard 30-day terms or on an extended term basis.basis and aircraft purchasers do not have the right to return the aircraft. Our contracts with the U.S. Department of Defense and its contractors are typically firm agreements to provide products and services at a fixed price and have a term of one year or less, frequently subject to extension for one or more additional periods of one year at the option of the U.S. Department of Defense.

Customers

Customers

For each of our reportable segments, we furnish aviationmarket and sell products and services primarily through our own employees. In certain markets, we rely on foreign sales representatives to assist in the sale of our products and services. The principal customers for our products and services in the Inventory and Logistic



ServicesAviation Supply Chain and Maintenance, Repair and Overhaul segments are domestic and foreign commercial airlines, regional and commuter airlines, business and general aviation operators, aviation original equipment manufacturers, aircraft leasing companies, domestic and foreign military organizations and independent aviation support companies. In the ManufacturingStructures and Systems segment, our principal customers include domestic and foreign military organizations, domestic and foreign commercial airlines, aviation original equipment manufacturers, large system providers and other industrial entities. The principal customers in the Aircraft and Engine Sales and Leasing segment include domestic and foreign commercial airlines and aircraft and engine finance and leasing companies. Sales of aviation products and services to commercial airlinesour airline customers are generally affected by such factors as the number, type and average age of aircraft in service, the levels of aircraft utilization (e.g., frequency of schedules), the number of airline operators and the level of sales of new and used aircraft. Sales to the U.S. Department of Defense are subject to a number of factors, including the level of troop deployment worldwide, competitive bidding, government funding and requirements generated by world events.

Licenses

We have 1412 Federal Aviation Administration (FAA) licensed repair stations in the United States and Europe. Of the 1412 licensed FAA repair stations, eightsix are also JointEuropean Aviation Authorities (JAA)Safety Agency (EASA) licensed repair stations. Such licenses, which are ongoing in duration, are required in order for us to perform authorized maintenance, repair and overhaul services for our customers and are subject to revocation by the government for non-compliance with applicable regulations. Of the 1412 FAA licensed repair stations, one is heldfour are in the Inventory and Logistic ServicesAviation Supply Chain segment, ninefive are held in the Maintenance, Repair and Overhaul segment, and fourthree are held in the ManufacturingStructures and Systems segment. Of the eight JAAsix EASA licensed repair stations, seventwo are heldin the Aviation Supply Chain segment, three are in the Maintenance, Repair and Overhaul segment and one is held in the ManufacturingStructures and Systems segment. We believe that we possess all licenses and certifications that are material to the conduct of our business.

Competition

Competition in the worldwide aviation/aerospace industryour markets is based on quality, ability to provide a broad range of products and services, speed of delivery and price. Competitors in both the Inventory and Logistic ServicesAviation Supply Chain and the Maintenance, Repair and Overhaul segments include original equipment manufacturers, the service divisions of large commercial airlines and other independent suppliers of parts and services. In our Aircraftrepair and Engine Sales and Leasing segment, we face competition from financial institutions, syndicators, commercial and specialized leasing companies and other entities that provide financing.overhaul services. Our pallet, container and shelter manufacturing activities in our ManufacturingStructures and Systems segment compete with several large and small companies, and our cargo systems and composite structures competitors include a number


of divisions of large corporations.corporations and small companies. In our Aircraft Sales and Leasing segment, we face competition from financial institutions, syndicators, hedge funds, commercial and specialized leasing companies and other entities that provide financing. Although certain of our competitors have substantially greater financial and other resources than we do, in each of our four reportable segments we believe that we have maintained a satisfactory competitive position through our responsiveness to customer needs, our attention to quality and our unique combination of market expertise and technical and financial capabilities.

Backlog

At May 31, 2004,2007, backlog believed to be firm was approximately $162,400$319,700 compared to $102,700$243,200 at May 31, 2003.2006. Approximately $148,200$268,300 of this backlog is expected to be filled within the next 12 months. The increase in our backlog reflects orders in our Manufacturing segment for products that support the U.S. Military's rapid deployment needs and cargo systems.

Employees

At May 31, 2004,2007, we employed approximately 2,3003,900 persons worldwide. We also retain approximately 600 contract workers, the majority of which are located at our airframe maintenance facilities.



Sales to U.S. GovernmentDepartment of Defense

Sales to the U.S. Government, its agenciesDepartment of Defense and its contractors were $222,558 (34.1%$325,280 (30.7% of total sales), $170,191 (28.1%$293,778 (33.2% of total sales), and $163,173 (25.5%$249,216 (33.7% of total sales) in fiscal years 2004, 20032007, 2006 and 2002,2005, respectively. Because such sales are subject to competitive bidding and government funding, no assurance can be given that such sales will continue at levels previously experienced. The majority of our government contracts are for aviation products and services used for ongoing routine military logistic support activities; unlike weapons systemsactivities and other high-technology military requirements, these products and services are less likelysubject to be affected by significant changes in defense spending. Our government contracts are subject to termination at the election of the government; in the event of such a termination we would be entitled to recover from the government all allowable costs incurred by us through the date of termination.

AdditionalAvailable Information

For additional information concerning our business segments, see Item 7, "Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations"Operations” and "Business“Business Segment Information"Information” in Note 1315 of Notes to Consolidated Financial Statements.Statements under Item 8, “Financial Statements and Supplementary Data”, below.

Our internet address iswww.aarcorp.com. We make available free of charge through our web site our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish such material to the SEC. Information contained on our web site is not a part of this report.

ITEM 1A.        RISK FACTORS

The following is a description of some of the principal risks inherent in our business. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us, or that we currently deem immaterial, could adversely impact our results of operations or financial condition in the future.


We may be affected by factors that adversely affect the aviation industry.

As a provider of products and services to the aviation industry, we are greatly affected by the overall economic condition of that industry. The aviation industry is historically cyclical. Early in calendar year 2001, the commercial aviation industry began to experience the negative effects of a worldwide economic downturn. The events of September 11, 2001 exacerbated that condition, resulting in a significant decline in air travel and reduced capacity by most of the major U.S.-based airlines. Since September 11, 2001, the aviation industry has also been negatively affected by historically high fuel prices, the war on terrorism and the outbreak of Severe Acute Respiratory Syndrome, or SARS. As a result of these and other events, certain customers filed for bankruptcy protection, including Air Canada, Aloha Airlines, Delta Air Lines, Mesaba Airlines, Northwest Airlines, U.S. Airways, United Airlines and Varig.

Our business, financial condition and results of operations may be adversely impacted by the following:

·       continued historically high fuel costs;

·       future terrorist attacks and the ongoing war on terrorism;

·       deterioration in the financial condition of our existing and potential customers;

·       reductions in the need for, or the deferral of, aircraft maintenance and repair services and spare parts support;

·       retirement of older generation aircraft, resulting in lower prices for spare parts and services for those aircraft;

·       reductions in demand for used aircraft and engines; and

·       future outbreaks of infectious diseases.

The economic and other factors affecting the aviation industry may have an adverse impact on our results of operations and financial condition.

Our customers may not be able to meet their financial obligations to us, which would adversely affect our financial condition and results of operations.

A number of our existing and prospective worldwide airline customers continue to suffer from the problems affecting the aviation industry, and some have filed for bankruptcy protection or are only recently emerging from bankruptcy. As a result, certain of these customers continue to pose credit risks to us. Our inability to collect receivables from one or more important customers could adversely affect our results of operations and financial condition.

The market value for our aviation products fluctuates.

We have used a number of assumptions when determining the recoverability of inventories and aircraft and engines which are on lease or available for lease. These assumptions include historical sales trends, current and expected usage trends, replacement values, current and expected lease rates, residual values, future demand, and future cash flows. Principally as a result of the events of September 11, 2001 and its impact on the global airline industry’s financial condition, fleet size and aircraft utilization, we recorded a significant charge for impaired inventories and engines during the second quarter of fiscal 2002 utilizing those assumptions. During the fourth quarter of fiscal 2003 and the first quarter of fiscal 2007, we recorded additional charges as a result of a further decline in market value for certain of these inventories, aircraft and engines. Further reductions in demand for our inventories or declining market values, as well as differences between actual results and the assumptions utilized by us when determining the recoverability of our inventories, aircraft and engines, could result in additional impairment charges in


future periods. We can give no assurance that future impairment charges for our inventories, aircraft and engines will not occur.

Our government contracts may not continue at present sales levels, which may have a material adverse effect on our financial condition and results of operations.

Our sales to the U.S. Department of Defense and its contractors were approximately $325,280 (30.7% of consolidated sales) in fiscal year 2007. The majority of our government contracts are for aviation products and services used for ongoing military logistic support activities and for products which support the U.S. military’s deployment strategy. Our contracts with the U.S. Department of Defense and its contractors are typically firm agreements to provide products and services at a fixed price and have a term of one year or less, frequently subject to extension for one or more additional periods of one year at the option of the U.S. Department of Defense. Sales to the U.S. Department of Defense are subject to a number of factors, including the level of troop deployment worldwide, competitive bidding, government funding and requirements generated by world events, and therefore may not continue at levels previously experienced, which could have an adverse effect on our results of operations and financial condition.

We face risks of cost overruns and losses on fixed-price contracts.

We sell certain of our products and services under firm, fixed-price contracts providing for fixed prices for the products and services, regardless of costs incurred by us. The cost of producing products or providing services may be adversely affected by increases in the cost of labor, materials, fuel, overhead and other unknown variants, including manufacturing and other operational inefficiencies and differences between assumptions used by us to price a contract and actual results. Increased costs may result in cost overruns and losses on such contracts which could adversely affect our results of operations and financial condition.

We may be unable to re-lease or sell currently leased aircraft and engines.

We purchase and lease aircraft and engines to our customers on an operating lease basis. Our ability to re-lease or sell these assets on acceptable terms is subject to a number of factors which drive industry capacity, including new aircraft deliveries, availability of used aircraft and engines in the marketplace, competition, financial condition of our customers, overall health of the airline industry and general economic conditions. Our inability to re-lease or sell aircraft and engines that are currently on lease could adversely affect our results of operations and financial condition.

Significant issues may develop associated with the A400M Cargo system.

In June 2005, we announced that our Cargo Systems business was selected to provide cargo handling systems for the new A400M Military Transport Aircraft (A400M). We are teaming with Pfalz Flugzeugwerke GmbH (PFW) of Speyer, Germany on the program. We have incurred, and are expected to continue to incur, significant development costs in connection with this program. Our portion of revenue to be generated from this program is expected to exceed $300,000 through fiscal 2015, based on sales projections of the A400M. We expect to begin shipments under this program during the second half of fiscal 2008. If the A400M experiences significant delivery delays or order cancellations, or if we fail to develop the system according to contract specifications, then our operating results and financial condition could be adversely affected.

The Indianapolis Maintenance Center success is dependent upon the hiring and retention of a large pool of skilled aircraft mechanics.

The Indianapolis Maintenance Center is comprised of 12 airframe maintenance bays (10 of which are available to us), as well as backshop, warehouse and office space. Revenues at the IMC fluctuate based on the demand for maintenance which, in turn, is driven by the number of aircraft operating and potential outsourcing of maintenance activities by airlines. Furthermore, we may not be able to hire and retain the


required amount of qualified licensed aircraft mechanics. As a result, we may not be able to execute our operational and financial plan at the IMC, which could adversely affect our results of operations and financial condition.

We operate in a highly competitive industry, and competitive pressures may adversely affect us.

The aviation industry and the markets for our products and services are highly competitive, and we face competition from a number of sources. Our competitors include aircraft manufacturers, aircraft parts manufacturers, airline and aircraft service companies, other companies providing maintenance, repair and overhaul services, and other aircraft spare parts distributors and redistributors. Some of our competitors have substantially greater financial and other resources than we have. We can give no assurance that competitive pressures will not adversely affect our results of operations and financial condition.

We are dependent upon continued availability of financing to manage our business and to execute our business strategy, and additional financing may not be available on terms acceptable to us.

Our ability to manage our business and to execute our business strategy is dependent, in part, on the continuing availability of debt and equity capital. Access to the debt and equity capital markets may be limited by various factors, including general economic conditions, the state of the aviation industry, our financial performance and current credit ratings. Debt and equity capital may not continue to be available to us on favorable terms, or at all. Our inability to obtain financing on favorable terms could adversely affect our results of operations and financial condition.

Our existing debt includes restrictive and financial covenants.

Certain of our loan agreements require us to comply with various restrictive covenants and some contain financial covenants that require us to comply with specified financial ratios and tests. Our failure to meet these covenants could result in default under these loan agreements and would result in a cross-default under other loan agreements. In the event of a default and our inability to obtain a waiver of the default, all amounts outstanding under loan agreements could be declared immediately due and payable. Our failure to comply with these covenants could adversely affect our results of operations and financial condition.

We are subject to significant government regulation and may need to incur significant expenses to comply with new or more stringent governmental regulation.

The aviation industry is highly regulated by the FAA in the United States and the equivalent regulatory agencies in other countries. Before we sell any of our products that are to be installed in an aircraft, such as engines, engine parts and components, and airframe and accessory parts and components, they must meet certain standards of airworthiness established by the FAA or the equivalent regulatory agencies in other countries. We also operate repair stations that are licensed by the FAA and in some cases the equivalent regulatory agencies in other countries. Specific regulations vary from country to country, although regulatory requirements in other countries are generally satisfied by compliance with FAA requirements. Although we believe we comply with all applicable regulatory standards, these standards may change in the future, requiring our inventory to be modified or scrapped. New and more stringent governmental regulations may be adopted in the future that, if enacted, may have an adverse impact on us. If material licenses, authorizations or approvals were revoked or suspended by the FAA and in some cases the equivalent regulatory agencies in other countries, our results of operations and financial condition may be adversely affected.

Acquisitions expose us to risks, including the risk that we may be unable to effectively integrate acquired businesses.

During fiscal 2007, we completed two acquisitions.  Further, we explore and have discussions with third parties regarding additional acquisitions on a regular basis. Acquisitions involve risks including


difficulties in integrating the operations and personnel of the acquired business, the effects of amortization of any acquired intangible assets and the potential impairment of goodwill on our financial results, and the potential loss of key employees of the acquired business. For the two acquisitions we made in fiscal 2007, and for any additional businesses we may acquire in the future, we may not be able to execute our operational, financial or integration plan of the acquired businesses, which could adversely affect our results of operations and financial condition.

Our industry is susceptible to product liability claims, and claims not adequately covered by insurance may adversely affect our financial condition.

Our business exposes us to possible claims for property damage and personal injury or death which may result if an engine, engine part or component, airframe part or accessory or any other aviation product which we have sold, manufactured or repaired fails or if an aircraft in which our products are installed crashes and the cause cannot be determined. We carry substantial liability insurance in amounts that we believe are adequate for our risk exposure and commensurate with industry norms. However, claims may arise in the future, and our insurance coverage may not be adequate to protect us in all circumstances. Additionally, we can give no assurance that we will be able to maintain adequate insurance coverage in the future at an acceptable cost. Any product liability claim not covered by adequate insurance could adversely affect our results of operations and financial condition.

We must comply with extensive environmental requirements, and any exposure to environmental liabilities may adversely affect us.

Federal, state and local requirements relating to the discharge of substances into the environment, the disposal of hazardous wastes, and other activities affecting the environment have had and may continue to have an impact on our operations. Compliance with environmental requirements and resolution of environmental claims have, in the past, been accomplished without material effect on our liquidity and capital resources, competitive position or financial condition. Management cannot assess the possible effect of compliance with future environmental requirements or of future environmental claims for which we may not have adequate indemnification or insurance coverage. If we were required to pay the expenses related to any future environmental claims for which neither indemnification nor insurance coverage were available, these expenses could have an adverse impact on our results of operations and financial condition. Additional information on environmental matters, including an administrative proceeding by the Michigan Department of Environmental Quality, is contained under Item 3 of this Annual Report on Form 10-K for the fiscal year ended May 31, 2007.

We may need to make significant capital expenditures to keep pace with technological developments in our industry.

The aviation industry is constantly undergoing development and change, and it is likely that new products, equipment and methods of repair and overhaul services will be introduced in the future. We may need to make significant capital expenditures to purchase new equipment and to train our employees to keep pace with any new technological developments. These capital expenditures could adversely affect our results of operations and financial condition.

Our operations would be adversely affected by a shortage of skilled personnel or work stoppages.

Because of the complex nature of many of our products and services, we are generally dependent on an educated and highly skilled workforce. Furthermore, we have collective bargaining agreements covering approximately 600 employees at three of our facilities. Our ability to operate successfully and meet our customers’ demands could be jeopardized if we are unable to attract and retain a sufficient number of skilled personnel to conduct our business, or if we experience a significant or prolonged work stoppage, and may adversely affect our results of operations and profitability.

9




ITEM 1B.       UNRESOLVED STAFF COMMENTS

None.


ITEM 2.                PROPERTIES

Our principal activities in the Aircraft and Engine Sales and Leasing segment and Inventory and Logistic Services segmentsparts distribution activities in the Aviation Supply Chain segment are conducted from a building owned by us in Wood Dale, Illinois, which is owned by us subject to a mortgage. In addition to warehouse space, this facility includes executive, sales and administrative offices. We also lease facilities in Atlanta and Macon, GeorgiaGeorgia; Jacksonville, Florida; Garden City, New York and Jacksonville, FloridaLondon, England, and we own a building near Schiphol International Airport in the Netherlands to support activities in the Inventory and Logistic ServicesAviation Supply Chain segment.

Our principal activities in the Maintenance, Repair and Overhaul activitiessegment are conducted in buildings ownedat facilities leased by us located in Frankfort, New York; Windsor, Connecticut (subject to an industrial revenue bond) and near Schiphol International Airport in The Netherlands. This segment also conducts overhaul and repair activities in buildings leased by the Company inIndianapolis, Indiana; Oklahoma City, Oklahoma; Miami, Florida; Garden City, New York; London, England; Roswell, New Mexico;Mexico and Oklahoma City, Oklahoma. In June 2004, we agreed to lease a portion of an aircraft maintenance facility in Indianapolis, Indiana.Hot Springs, Arkansas.

Our principal activities in the ManufacturingStructures and Systems segment are conducted at facilities owned by us in Clearwater, Florida (subject to an industrial revenue bond) and; Cadillac and Livonia, Michigan.Michigan; Goldsboro, North Carolina and Frankfort, New York. We also lease facilities in Huntsville, Alabama.

We also operate sales offices which support all our activities and are leased in London, England; Melbourne, Australia; Paris, France; Rio de Janeiro, Brazil; Shanghai, China; Singapore, Republic of Singapore and Tokyo, Japan.

We believe that our owned and leased facilities are suitable and adequate for our operational requirements.



ITEM 3.                LEGAL PROCEEDINGS (Dollars
(Dollars in thousands)

Except as described below, we are not a party to any material, pending legal proceeding (including any governmental or environmental proceedings) other than routine litigation incidental to our existing business.

AAR Manufacturing, Inc., a subsidiary of the Company ("subsidiary"(“subsidiary”) received an Administrative Order for Response Activity ("Order"(“Order”) dated August 7, 2003, from the Michigan Department of Environmental Quality ("MDEQ"(“MDEQ”) relating to environmental conditions at and in the vicinity of our subsidiary'sthe subsidiary’s Cadillac, Michigan plant. The Order requires ourthe subsidiary to perform environmental investigatory work, prepare a feasibility study and a remedial action plan, and perform interim response actions. The interim response actions include continuation of the response activities ourthe subsidiary is performing under a 1985 Consent Decree, operation of a soil vapor extraction system ourthe subsidiary had previously installed and operated, determination of the need to provide alternate water supplies to off-site properties (and if it is so determined then to actually provide it)them), removal of any free phase liquids encountered in the ground, providing notices of groundwater contamination migration to off-site property owners, and other actions determined by the MDEQ or ourthe subsidiary to be appropriate. A letter dated June 14, 2002 from theThe MDEQ further demands payment of environmental response costs already incurred by the MDEQ in the approximate amount of $525$2,500 plus interest, plusand reimbursement of unspecified costs to be incurred in the future by the MDEQ. The Order and the letter which accompanies the Orderaccompanying it threaten the imposition of civil fines up to $25 for each day of violation of the Order, plus exemplary damages up to three times the costs incurred by the MDEQ if ourthe subsidiary does not comply with the Order. The Order may require the implementation of the remedial action plan, although it is not clear on that point. The Order requires the implementation of emergency response action if a release of hazardous substances, threat of a release, or exacerbation of existing contamination occurs during the pendency of the Order.

        OurThe subsidiary advised the MDEQ that it willwould perform the requirements of the Order to the extent those requirements apply to the allegation by the MDEQ that a release of hazardous substances occurred


after the execution of the 1985 Consent Decree. OurThe subsidiary declined to perform certain work required underby the Order which ourthat the subsidiary believes is based on claims resolved in the 1985 Consent Decree. The MDEQ responded to ourthe subsidiary by saying that the MDEQ "will“will be taking appropriate action to protect public health, safety and welfare and the environment, and gain AAR'sAAR’s compliance with Part 201."201” (the Michigan “cleanup law”).

        OurThe subsidiary has spent approximately $100 in performing environmental investigations underreceived funds from an insurance carrier to reimburse it for a portion of the Order. Oursubsidiary’s costs. The subsidiary may conduct work undersought coverage from another insurance company and that carrier is paying a portion of defense costs, but has reserved its rights on coverage for the litigation noted below. The subsidiary has filed suit against one of the insurance carriers for breach of contract and other relief and recently reached a settlement.

Prior to the issuance of the Order, in additionthe subsidiary sought a Court order to enforce the 1985 Consent Decree, but that relief was denied by the Court, primarily on the basis that the action was premature since the State was not pursuing an enforcement action at the time. The subsidiary sought leave to appeal that decision to the work to be performed noted above. We believe theMichigan Court of Appeals, but leave was denied.

The work performed and data gathered by ourthe subsidiary since the issuance of the Order supportsappears to support the positions previously taken by ourthe subsidiary regarding the movement of groundwater in the vicinity of our subsidiary's plant and the ongoing capture of groundwater for treatment by ourthe subsidiary. However, there continues to beThere is disagreement between our subsidiary andwith the MDEQ concerningregarding the conclusions to be drawn from the data developed from that work. No action has been taken by the MDEQ to enforce the Order against our subsidiary, although theThe MDEQ has retained contractors to perform environmental investigations in the vicinity of our subsidiary'sthe plant.

On March 31, 2005, a complaint was filed by the MDEQ in Cadillac, Michigan with the Wexford County Circuit Court. The case is Michigan Department of Environmental Quality v AAR Cadillac Manufacturing, a division of AAR Manufacturing Group, Inc., an Illinois corporation, and AAR Corp., a Delaware corporation, File No. 05-18853-CE. In its complaint, the MDEQ seeks to enforce the Order against the subsidiary and to have the Court impose civil fines and exemplary damages upon the subsidiary for the alleged failure to comply with the Order. The MDEQ seeks to recover its costs incurred in performing response activities from both the subsidiary and the Company and seeks a declaratory judgment that both are liable for all future costs incurred by the State at the facility. The MDEQ also seeks civil fines from the subsidiary for alleged violations of a particular section of a Michigan environmental law.

The Company and the subsidiary filed their Answer, including Affirmative Defenses, and intend on vigorously defending the complaint filed by the MDEQ. On June 17, 2005, the subsidiary also filed a Petition for Reimbursement of its costs in the amount of approximately $200 incurred in complying with the Order from the State of Michigan cleanup and redevelopment fund established under Michigan law, plus costs and attorney fees. As of May 31, 2007, the subsidiary has charged to operations $1,309 related to this matter. The MDEQ has filed a motion for summary disposition which is scheduled for an August 20, 2007 hearing.


ITEM 4.                SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.



Supplemental Item:

EXECUTIVE OFFICERS OF THE REGISTRANT

Information concerning each of our executive officers is set forth below:

Name

Name


Age


Present Position with the Company


David P. Storch

51

54

President

Chairman and Chief Executive Officer, Director

Timothy J. Romenesko

50

President and Chief Operating Officer, Director

Richard J. Poulton

42

Vice President, Chief Financial Officer and Treasurer

Howard A. Pulsifer

61

64

Vice President, General Counsel and Secretary

Timothy J. Romenesko47Vice President and Chief Financial Officer

James J. Clark

44

47

Group Vice President, Maintenance, Repair and OverhaulAviation Supply Chain

Michael J. Mark McDonaldSharp

44

45

Group

Vice President, ManufacturingController and Chief Accounting Officer

 

Mr. Storch has served as Presidentwas elected Chairman of the Company since 1989Board and Chief Executive Officer since 1996.in October 2005.  Previously, he served as President and Chief Executive Officer from 1996 to 2005 and Chief Operating Officer from 1989 to 1996 and1996. Prior to that, he served as a Vice President of the Company from 1988 to 1989. Mr. Storch joined the Company in 1979 and also served as president of a major subsidiary from 1984 to 1988. Mr. Storch has been a director of the Company since 1989.

Mr. Storch is Ira A. Eichner's son-in-law. Mr. Eichner is ChairmanRomenesko was appointed President and Chief Operating Officer effective June 1, 2007. Previously, he served as Vice President and Chief Financial Officer since 1994. He also served as Controller of the BoardCompany from 1991 to 1995, and in various other positions since joining the Company in 1981. Mr. Romenesko was appointed a Directordirector of the Company.Company in July 2007.

Mr. Poulton was appointed Vice President, Chief Financial Officer and Treasurer effective June 1, 2007. Previously he served as Vice President of Acquisitions and Strategic Investments since joining the Company in September 2006. Prior to joining the Company, he spent ten years in the aviation industry and held senior executive leadership positions with UAL Corporation, including Senior Vice President of Business Development and Senior Vice President and Chief Procurement Officer for United Airlines, Inc.

Mr. Pulsiferhas served as Vice President, General Counsel and Secretary of the Company since 1990. Previously, he served as Vice President (since 1990) and General Counsel (since 1987). HePrior to joining AAR, he was previously with United Airlines, Inc. for 14 years, most recently as Senior Counsel.years.

Mr. Romenesko has served as Vice President and Chief Financial Officer since 1994. Previously, he served as Controller of the Company from 1991 to 1995 and in various other positions since joining the Company in 1981.

Mr. Clarkhas served as Group Vice President, Maintenance, Repair and OverhaulAviation Supply Chain since 2000.2005. Previously, he wasserved in various Group Vice President roles from 2000 to 2005, and previous to that he served as General Manager of AAR Aircraft Component Services—Amsterdam from 1995 to 2000, and in various other positions since joining the Company in 1982.

Mr. McDonaldSharp has served as Group Vice President, ManufacturingController and Chief Accounting Officer since 2003.1999. Previously, he served as General ManagerController of AAR Mobility Systems from 2000 to 2003 and as Vice President of Operationsthe Company from 1996 to 2003. He1999. Prior to joining the Company he was previously with General Electric in various positionsKraft Foods from 1994 to 1996, and with KPMG LLP from 1984 to 1996.1994.

Each executive officer is elected annually by the Board of Directors at the first meeting of the Board held after the annual meeting of stockholders. Executive officers continue to hold office until their successors are duly elected or until their death, resignation, termination or reassignment.

12





PART II


PART II

ITEM 5.                MARKET FOR REGISTRANT'SREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
(Dollars in thousands, except per share amounts)

 

Our Common Stock is traded on the New York Stock Exchange and the Chicago Stock Exchange. On July 1, 20042007 there were approximately 7,000 holders of Common Stock, including participants in security position listings.

        Certain of our financing arrangements contain provisions restricting the payment of dividends or repurchase of our shares. See Note 3 of Notes to Consolidated Financial Statements included herein. Under the most restrictive of these provisions, we may not pay dividends (other than stock dividends) or acquire our capital stock if, after giving effect to the aggregate amounts paid on or after June 1, 1995, such amounts exceed the sum of $20,000 plus 50% of Consolidated Net Income (Loss) after June 1, 1994. We are currently prohibited from paying dividends or purchasing our shares pursuant to this provision, and during fiscal 2004 and 2003 we did not purchase any of our equity securities.

The table below sets forth for each quarter of the past two fiscal year indicatedyears the reported high and low closing market prices of our Common Stock on the New York Stock Exchange and the quarterly dividends declared. We suspended payment of dividends in October 2002.Exchange.


 Fiscal 2004
 Fiscal 2003

 

Fiscal 2007

 

Fiscal 2006

 

Per Common Share
 Market Prices
  
 Market Prices
  
Quarterly
Dividends

 Quarterly
Dividends

 

Market Prices

 

Market Prices

 

Quarter
 High
 Low
 High
 Low

 

High

 

Low

 

High

 

Low

 

First $8.34 $4.72 $.000 $11.15 $6.00 $.025

 

$

25.17

 

$

19.50

 

$

17.97

 

$

14.94

 

Second 11.38 7.30 .000 6.11 3.20 .000

 

27.69

 

22.24

 

20.94

 

15.10

 

Third 16.37 10.25 .000 6.09 4.45 .000

 

31.52

 

26.32

 

26.42

 

20.50

 

Fourth 13.09 8.72 .000 4.50 3.70 .000

 

33.55

 

27.40

 

29.00

 

24.05

 

     
     
     $.000     $.025
     
     

13





ITEM 6.                SELECTED FINANCIAL DATA

(In thousands, except per share amounts)



 For the Year Ended May 31,

 

For the Year Ended May 31,

 



 2004
 2003
 2002
 2001
 2000

 

2007

 

2006

 

2005

 

2004

 

2003

 

RESULTS OF OPERATIONSRESULTS OF OPERATIONS          

 

 

 

 

 

 

 

 

 

 

 

Sales $651,958 $606,337 $638,721 $853,659 $957,525
Pass through sales1    20,596 66,808
Total sales 651,958 606,337 638,721 874,255 1,024,333
Gross profit 100,707 77,058 13,848 136,467 172,853
Operating income (loss) 18,778 (1,787)2 (81,289)2 40,390 70,658
Interest expense 18,819 19,539 19,798 21,887 23,431
Income (loss) before provision for income taxes 1,707 (19,490) (98,229) 20,220 49,526
Net income (loss) 3,504 (12,410) (58,939) 18,531 35,163
 
 
 
 
 

Share data:

 

 

 

 

 

 

 

 

 

 
 Earnings (loss) per share—basic $0.11 $(0.39)$(2.08)$0.69 $1.30
 Earnings (loss) per share—diluted $0.11 $(0.39)$(2.08)$0.69 $1.28
 Cash dividends per share $0.00 $0.03 $0.16 $0.34 $0.34
 Weighted average common shares outstanding—basic 32,111 31,852 28,282  3 26,913 27,103
 
 
 
 
 
 Weighted average common shares outstanding—diluted 32,392 31,852 28,282  3 26,985 27,415
 
 
 
 
 

Sales from continuing operations3

 

$

1,061,169

 

$

885,518

 

$

740,427

 

$

632,223

 

$

589,085

 

Gross profit

 

184,147

1

163,221

 

120,575

 

100,389

 

77,581

1

Operating income

 

95,366

1

65,172

 

34,917

 

21,612

 

2,431

1

Gain (loss) on extinguishment of debt

 

2,927

 

(3,893

)

3,562

 

 

 

Interest expense

 

16,701

 

18,004

 

16,917

 

18,691

 

19,416

 

Income (loss) from continuing operations3

 

59,447

 

35,823

 

19,498

 

5,430

 

(9,589

)

Loss from discontinued operations3

 

(787

)

(660

)

(4,045

)

(1,926

)

(2,821

)

Net income (loss)

 

58,660

 

35,163

 

15,453

 

3,504

 

(12,410

)

Share data:

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per share-basic:

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) from continuing operations

 

$

1.63

 

$

1.07

 

$

0.60

 

$

0.17

 

$

(0.30

)

Loss from discontinued operations

 

(0.02

)

(0.02

)

(0.12

)

(0.06

)

(0.09

)

Earnings (loss) per share-basic

 

$

1.61

 

$

1.05

 

$

0.48

 

$

0.11

 

$

(0.39

)

Earnings (loss) per share-diluted:

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) from continuing operations

 

$

1.42

 

$

0.96

 

$

0.57

 

$

0.17

 

$

(0.30

)

Loss from discontinued operations

 

(0.02

)

(0.02

)

(0.11

)

(0.06

)

(0.09

)

Earnings (loss) per share-diluted

 

$

1.40

 

$

0.94

 

$

0.46

 

$

0.11

 

$

(0.39

)

Cash dividends per share

 

$

0.00

 

$

0.00

 

$

0.00

 

$

0.00

 

$

0.03

 

Weighted average common shares outstanding—basic

 

36,389

 

33,530

 

32,297

 

32,111

 

31,852

 

Weighted average common shares outstanding—diluted

 

43,309

 

38,852

 

36,205

 

32,392

 

31,852

 

FINANCIAL POSITIONFINANCIAL POSITION          

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents $41,010 $29,154 $34,522 $13,809 $1,241
Working capital 300,943 192,837 286,192 352,731 345,304
Total assets 709,292 686,621 710,199 701,854 737,977
Short-term recourse debt 2,656 59,729 42,525 13,652 26,314
Short-term non-recourse debt 736 32,527   
Long-term recourse debt 217,434  4 164,658 217,699 179,987 180,447
Long-term non-recourse debt 31,232    
Total recourse debt 220,090 224,387 260,224 193,639 206,761
Stockholders' equity 301,684 294,988 310,235 340,212 336,494
 
 
 
 
 
Number of shares outstanding at end of year 32,245 31,850 31,870  3 26,937 26,865
 
 
 
 
 
Book value per share of common stock $9.36 $9.26 $9.73 $12.63 $12.53
 
 
 
 
 

Total cash and cash equivalents

 

$

83,317

 

$

121,738

 

$

50,338

 

$

41,010

 

$

29,154

 

Working capital

 

389,215

 

436,666

 

314,517

 

300,943

 

192,837

 

Total assets

 

1,067,633

 

978,819

 

732,230

 

709,292

 

686,621

 

Short-term recourse debt

 

51,366

 

361

 

2,123

 

2,656

 

59,729

 

Short-term non-recourse debt

 

22,879

 

1,928

 

1,622

 

736

 

32,527

 

Long-term recourse debt

 

232,863

 

293,263

4,5

199,919

 

217,434

2

164,658

 

Long-term non-recourse debt

 

20,748

 

25,313

 

27,240

 

31,232

 

 

Total recourse debt

 

284,229

 

293,624

 

202,042

 

220,090

 

224,387

 

Stockholders’ equity

 

494,243

 

422,717

5

314,744

 

301,684

 

294,988

 

Number of shares outstanding at end of year

 

37,729

 

36,654

 

32,586

 

32,245

 

31,850

 

Book value per share of common stock

 

$

13.10

 

$

11.53

 

$

9.66

 

$

9.36

 

$

9.26

 


Notes:

1

In connection with certain long-term inventory management programs,fiscal 2007 and 2003, we purchased factory-new products on behalfrecorded $7,652 and $5,360, respectively, of our customers from original equipment manufacturers. These products were purchased fromimpairment charges related to engines and engine and airframe parts. A portion of the manufacturer and "passed through"fiscal 2007 charge related to our customers at our cost. In December 2000, these inventory management programs were discontinued.

2
an aircraft. See Note 213 of notesNotes to our consolidated financial statements for a discussion regarding impairment and special charges recorded during fiscal 2003 and fiscal 2002.

Consolidated Financial Statements.

32

In February 2002, we sold 5,010 shares of common stock for $34,334, net of expenses.

4
In February 2004, we sold $75,000 of 2.875% convertible notes due February 1, 2024.

3During fiscal 2007, we decided to exit our non-core industrial turbine business located in Frankfort, New York. In February 2005, we sold our engine component repair business located in Windsor, Connecticut. The operating results and the loss on disposal are classified as discontinued operations. See Note 10 of Notes to Consolidated Financial Statements.

4In February 2006, we sold $150,000 of 1.75% convertible notes due February 1, 2026. See Note 2 of Notes to Consolidated Financial Statements.

5In January and February 2006, we acquired approximately $50,645 aggregate principal amount of our 2.875% Convertible Senior Notes due February 1, 2024 in exchange for an aggregate 2,724 shares of our common stock plus $3,893 in cash. See Note 1 of Notes to Consolidated Financial Statements.

14




ITEM 7.    MANAGEMENT'S                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

(Dollars in thousands)

General Overview

        We report our activities in four business segments: Inventory and Logistic Services; Maintenance, Repair and Overhaul; Manufacturing; and Aircraft and Engine Sales and Leasing.

        Sales in the Inventory and Logistic Services segment are derived from the sale of a wide variety of new, overhauled and repaired engine and airframe parts and components to the commercial aviation and military markets, as well as the distribution of new airframe parts purchased from various original equipment manufacturers and sold to commercial and general aviation customers. Cost of sales consists principally of the cost of product (primarily aircraft and engine parts) and overhead (primarily indirect labor, facility cost and insurance).

        Sales in the Maintenance, Repair and Overhaul segment are derived from the repair and overhaul of a wide range of commercial and military aircraft engine and airframe parts, landing gear and components; aircraft maintenance and storage; and the repair, overhaul and sale of parts for industrial gas and steam turbine operators. Cost of sales consists principally of cost of product (primarily replacement aircraft parts), direct labor and overhead.

        Sales in the Manufacturing segment are derived from the manufacture and sale of a wide array of containers, pallets and shelters used to support the U.S. Military's tactical deployment requirements, in-plane cargo loading and handling systems for commercial and military applications and advanced composite materials and components for aerospace and industrial use. Cost of sales consists principally of the cost of product, direct labor and overhead.

        Sales in the Aircraft and Engine Sales and Leasing segment are derived from the sale and lease of commercial aircraft and engines and technical and advisory services. Cost of sales consists principally of cost of product (aircraft and engines), labor and the cost of lease revenue (primarily depreciation, lease expense and insurance).

        The table below sets forth consolidated sales for our four business segments for each of the last three fiscal years ended May 31.

 
 For the Year Ended May 31,
 
 2004
 2003
 2002
Sales:         
 Inventory and Logistic Services $253,958 $246,031 $258,067
 Maintenance, Repair and Overhaul  216,483  205,666  216,727
 Manufacturing  151,310  119,871  99,558
 Aircraft and Engine Sales and Leasing  30,207  34,769  64,369
  
 
 
  $651,958 $606,337 $638,721
  
 
 

        As a result of the events of September 11, 2001, which occurred at a time when the worldwide commercial airline environment was already under significant pressure principally due to an economic downturn, most of the major U.S. based commercial airlines announced substantial reductions in capacity, some in excess of 20%. Commercial airlines accelerated their older generation aircraft fleet retirement plans. The reduction in industry-capacity and the financial impact of the events of September 11, 2001 on our customers had a significant negative effect on our fiscal 2002 sales and operating results as demand declined for our products and services within the Inventory and Logistic Services, Maintenance, Repair and Overhaul and Aircraft and Engine Sales and Leasing segments.



        During fiscal 2003, airline traffic began to strengthen and it appeared that the beginning of the airline industry recovery was underway. However, during the third quarter of fiscal 2003, demand for products and services from many of our airline customers weakened as a result of the war in Iraq and the outbreak of Severe Acute Respiratory Syndrome (SARS). During fiscal 2003, sales of products and services to the U.S. Government, its agencies and its contractors increased primarily due to increased U.S. Military activity.

        During fiscal 2004, sales of our manufactured products and performance-based logistics and supply chain management services continued to increase as a result of the U.S. Military's buildup and increased demand for supply chain management services. Although it is very difficult for us to predict the extent and duration of the military buildup and its impact on our near-term results, we believe that we are well positioned with our current products and services and growth plans to benefit from longer-term U.S. Military deployment and program-management strategies. Total sales to the U.S. Government and its contractors for fiscal 2004 were $222,558, an increase of 30.8% compared to fiscal 2003, and represented 34.1% of fiscal 2004 consolidated sales.

        During fiscal 2004, there have been positive signs the airline industry is improving, such as year-over-year improvement in available seat miles, revenue passenger miles and load factors. However, rising fuel prices and high labor costs continue to threaten the commercial airline industry, and recently certain major U.S. carriers warned they may be forced to file for bankruptcy protection. Low cost carriers with little or no infrastructure to support their maintenance requirements have gained market share from the major U.S. carriers. Certain of these low cost carriers are flying newer aircraft which will generate demand for maintenance in future years. We anticipate a fundamental shift in the way our airline customers manage their business, including intensified focus on cost control and increased use of third-party maintenance providers. We believe we are well positioned with our broad range of products and services as these trends develop.

Factors Which May Affect Future Results

        Our operating results and financial position may be adversely affected or fluctuate on a quarterly basis as a result of general economic conditions, geo-political events, the commercial airline environment and other factors, including: (1) declining demand for our products and services and the ability of our customers to meet their financial obligations; (2) declining market values for aviation products and equipment; (3) difficulties in re-leasing or selling aircraft and engines that are currently being leased; (4) lack of assurance that sales to the U.S. Government, its agencies and its contractors (which were 34.1% of total sales in fiscal 2004), will continue at levels previously experienced; (5) access to the debt and equity capital markets and the ability to draw down funds under financing agreements; (6) non-compliance with restrictive and financial covenants contained in certain of our loan agreements; (7) changes in or non-compliance with laws and regulations that may affect certain of our aviation related activities that are subject to licensing, certification and other regulatory requirements imposed by the FAA and other regulatory agencies, both domestic and foreign; (8) competition from other companies, including original equipment manufacturers, some of which have greater financial resources than us; (9) exposure to product liability and property claims that may be in excess of our substantial liability insurance coverage; and (10) the outcome of any pending or future material litigation or environmental proceedings.


Results of Operations

Fiscal 2004 Compared with Fiscal 2003

        Consolidated sales for fiscal 2004 were $651,958, which represents an increase of $45,621 or 7.5% compared to fiscal 2003.

        In the Inventory and Logistic Services segment, fiscal 2004 sales increased $7,927 or 3.2% compared to fiscal 2003. The increase in sales compared to the prior year is primarily attributable to higher sales to the U.S. Military and its contractors for spares and logistics support and increased sales of engine parts. In the Inventory and Logistic Services segment, we experienced lower sales of parts to general aviation customers as a result of our strategic decision to de-emphasize certain lower margin products. Going forward, we will continue our strategy of focusing on the distribution of higher margin products.

        In the Maintenance, Repair and Overhaul segment, fiscal 2004 sales increased $10,817 or 5.3% compared with fiscal 2003. The increase in sales compared to the prior year is primarily attributable to higher sales at our aircraft maintenance facility due to an increase in the number of long-term maintenance contracts with certain customers. At certain of our component repair facilities, demand for component repair from our commercial airline customers has not recovered, and as a result we experienced lower sales compared to the prior year.

        In the Manufacturing segment, fiscal 2004 sales increased $31,439 or 26.2% compared to fiscal 2003. The increase in sales compared to the prior year is due to record shipments of our manufactured products which support the U.S. Military tactical deployment activities. In the Manufacturing segment, we experienced lower sales of our non-aviation composite structure products as a result of the completion of a major contract in May 2003.

        In the Aircraft and Engine Sales and Leasing segment, fiscal 2004 sales decreased $4,562 or 13.1%. Sales in this segment remain at historically low levels.

        Consolidated gross profit increased $23,649 or 30.7% compared with the prior year. The increase in our consolidated gross profit is primarily due to the increase in sales and an increase in our consolidated gross profit margin to 15.4% from 12.7% in the prior year. During the fourth quarter of fiscal 2004, we wrote off an investment in a joint venture (see Note 11) and the associated $1,269 pre-tax charge was recorded in Cost of Sales on the Consolidated Statement of Operations. The gross margin percentage increased in the Inventory and Logistic Services segment primarily due to the mix of inventories sold and in the Manufacturing segment primarily due to increased volume at our facilities that manufacture products supporting the U.S. Military's tactical deployment activities. Fiscal 2003 gross profit included the $5,360 impairment reserve recorded in May 2003.

        Operating income increased $20,565 compared with the prior year primarily due to the increase in gross profit. During fiscal 2004, our selling, general, administrative and other expenses increased by $3,084 compared with fiscal 2003 primarily as a result of a provision for an unfavorable judgement in the amount of $1,600, a provision for a customer allowance of $1,335 and slightly higher personnel costs, partially offset by a $836 gain recorded from the sale of a facility located in Holtsville, New York. Interest expense decreased $720 compared to the prior year primarily due to decreased average borrowings.

        During the third quarter of fiscal 2004, upon completion of our fiscal 2003 Federal income tax return, we determined that we qualified for additional tax benefits of $604 related primarily to higher than estimated margin on export activities. This benefit was recorded in the third quarter. In addition, our effective tax rate for fiscal 2004 reflects increased expected tax benefits related to current year export activities. As a result of these items, we recorded a tax benefit of $1,797 for the fiscal year ended May 31, 2004.

        As a result of the factors discussed above, we reported net income of $3,504 for fiscal 2004.



Fiscal 2003 Compared with Fiscal 2002

        Consolidated sales for fiscal 2003 were $606,337, which represents a decrease of $32,384 or 5.1% compared to fiscal 2002.

        In the Inventory and Logistic Services segment, fiscal 2003 sales declined $12,036 or 4.7% compared to fiscal 2002. The decrease in sales compared to the prior year was attributable to a $16,660 reduction in sales to general aviation customers as a result of management's decision to reduce its investment in the low-margin general aviation market by eliminating most general aviation branch locations and reducing staff levels. In the Inventory and Logistics Services segment, we experienced increased sales to the U.S. Military for spares and logistics support and higher sales of serviceable parts to certain program customers.

        In the Maintenance, Repair and Overhaul segment, fiscal 2003 sales declined $11,061 or 5.1% compared to fiscal 2002. The decrease in sales compared to the prior year was attributable to lower sales in the U.S., partially offset by increased component overhaul sales in Europe primarily due to favorable changes in currency translation rates.

        In the Manufacturing segment, fiscal 2003 sales increased $20,313 or 20.4% as we experienced record demand for our manufactured products which support the U.S. Military deployment activities. Increased shipments of our non-aviation related composite structure products also contributed to higher sales within this segment.

        In the Aircraft and Engine Sales and Leasing segment, fiscal 2003 sales declined $29,600 or 46.0%. Sales in this segment are principally comprised of lease revenues from aircraft and engines on lease to operators, as well as sales of aircraft and engines. Sales in this segment remain historically low, reflecting the lack of sales activity caused by the aviation industry-wide reduction in demand for capital assets post September 11, 2001.

        During the fourth quarter of fiscal 2003, we recorded impairment charges related to certain engine and airframe parts and whole engines in the amount of $5,360. The fiscal 2003 impairment charge was based upon an updated assessment of the net realizable values for certain engine and airframe parts and future undiscounted cash flows for whole engines. Of the $5,360 impairment charge recorded during fiscal 2003, $2,360 was related to the Inventory and Logistic Services segment, and $3,000 related to the Aircraft and Engine Sales and Leasing segment.

        Consolidated gross profit, before consideration of impairment charges in fiscal 2003 and 2002, decreased $7,330 or 8.2% as a result of lower sales and a reduction in the consolidated gross profit margin from 14.1% in fiscal 2002 to 13.6% in fiscal 2003. The reduction in the consolidated gross profit margin was primarily attributable to lower margins experienced in the Maintenance, Repair and Overhaul segment, as well as lower volume through most of the facilities within that segment, partially offset by an increase in the gross profit margin in the Manufacturing segment due principally to increased volume and the mix of products sold. Including the effect of the impairment charges recorded in fiscal 2003 and 2002, consolidated gross profit increased $63,210.

        Operating income, before consideration of impairment and other special charges, decreased $1,138 as a result of lower sales and a reduction in the consolidated gross profit margin, partially offset by lower selling, general and administrative expenses. During fiscal 2003, we reduced our selling, general and administrative expenses by $6,192 or 7.3% principally as a result of lower personnel costs and reduced discretionary spending. Interest expense decreased $259 compared to the prior year principally due to decreased average borrowings during fiscal 2003. Interest income decreased $1,022 over the prior year due to a decline in average cash invested during the fiscal year and lower interest rates.

        Our effective tax benefit rate for fiscal 2003 was 36.3% compared to 40.0% in fiscal 2002. The fiscal 2002 income tax benefit includes a $2,000 reduction in income tax expense representing the reversal of federal income tax liabilities. This adjustment reduced federal and state income tax expense primarily



recorded during the fiscal years 1999 through 2001, related to incentives on exports and tax credits. A change in tax law effective in fiscal 2002 regarding the computation of export incentives, combined with previous experience with tax examinations, resulted in the reduction in the tax expense.

        We recorded a net loss of $12,410 during fiscal 2003 due to the factors discussed above.

Liquidity and Capital Resources

        Historically, we have funded our operating activities and met our commitments through the generation of cash from operations, augmented by the periodic issuance of common stock and debt in the public and private markets. In addition to these cash sources, we also rely on secured credit arrangements, which currently include an accounts receivable securitization program and a secured revolving credit facility. Our continuing ability to borrow from our lenders and issue debt and equity securities to the public and private markets in the future may be negatively affected by a number of factors, including general economic conditions, airline and aviation industry conditions, geo-political events, including the war on terrorism, and our operating performance. Our ability to use our accounts receivable securitization program and revolving credit facility is also dependent on these factors. Our ability to generate cash from operations is influenced primarily by our operating performance and working capital management. We also have a universal shelf registration on file with the Securities and Exchange Commission under which, subject to market conditions, up to $163,675 of common stock, preferred stock or medium- or long-term debt securities may be issued or sold.

        At May 31, 2004, our liquidity and capital resources included cash of $41,010 and working capital of $300,943. As of May 31, 2004, $7,313 of cash was restricted to support letters of credit. At May 31, 2004, we had $35,000 available under our accounts receivable securitization program; no accounts receivable were securitized as of that date. The amount available under this agreement is based on a formula of qualifying accounts receivable. At May 31, 2004, we had $22,449 available under our secured revolving credit facility; no amounts were outstanding as of that date. The amount available under the revolving credit facility is also based on a formula of qualifying assets. As of May 31, 2004, unrestricted cash and amounts available to us under our secured credit arrangement and accounts receivable securitization program totaled $91,146.

        On February 3, 2004, we issued $75,000 principal amount of 2.875% convertible notes due February 1, 2024. We used a portion of the proceeds to repurchase $35,000 of accounts receivable which had been sold under our accounts receivable securitization facility, to repay $16,900 of 8.0% notes prior to their maturity, to repay $4,000 outstanding under our revolving credit facility, to retire $13,426 of notes payable due in June 2005 and to retire $3,500 of notes payable due in December 2007 (see Note 3).

        In January 2004, we refinanced non-recourse notes of $32,132 with the maturity date extended to July 2005. Accordingly, a portion of the non-recourse debt has been classified as long-term on the May 31, 2004 Consolidated Balance Sheet. As of May 31, 2004, our equity investment in the aircraft that secures the non-recourse debt was $2,085.

        On October 3, 2003, we entered into a sale-leaseback transaction whereby we sold and leased back a facility in Garden City, New York. Net proceeds from the sale were $13,991 and were used in part to reduce our outstanding borrowings (see Note 9).

        On July 1, 2003, we completed an $11,000 financing secured by a mortgage on our Wood Dale, Illinois facility. The term of the financing is five years utilizing a fifteen-year amortization with a LIBOR-based interest rate of no less than 6.25%.

        On April 18, 2003, Standard and Poor's downgraded the senior unsecured debt rating to BB minus from BBB minus with an outlook rating of negative. On July 2, 2004, Standard and Poor's upgraded our outlook rating from negative to stable. On July 18, 2003, Fitch Ratings downgraded the unsecured debt rating to BB minus from BB plus and revised the outlook rating to negative from stable. On August 5,



2003, Moody's Investors Service downgraded our senior unsecured debt rating to B2 from B1. We were removed from credit watch following the downgrade actions by each of the respective rating agencies.

        We continue to evaluate financing arrangements on commercially reasonable terms that will allow us to improve our liquidity position and finance future growth. Our ability to obtain additional financing is dependent upon a number of factors, including the geo-political environment, general economic conditions, airline industry conditions, our operating performance and market conditions in the public and private debt and equity markets.

        During the twelve-month period ended May 31, 2004, we generated $14,572 of cash from operations primarily due to a reduction in inventories of $15,602 and $26,680 of non-cash depreciation and amortization. However, accounts and trade notes receivables increased $41,374 as a result of an increase in sales and the repurchase for cash of $26,800 of accounts receivable which had been sold under our accounts receivable securitization facility.

        During the twelve-month period ended May 31, 2004, cash provided from investing activities was $5,626 consisting primarily of proceeds from the sale and leaseback of our Garden City, New York facility in the amount of $13,991 and proceeds from the sale of the Holtsville, New York facility in the amount of $2,931, partially offset by capital expenditures of $10,286. We expect fiscal 2005 capital expenditures to be $13,000 to $15,000, reflecting increased investments in airframe maintenance and higher-margin manufacturing capabilities.

        During the twelve-month period ended May 31, 2004, our financing activities used $8,373 of cash. Proceeds from borrowings during fiscal 2004 were $89,701, which included the issuance of $75,000 of 2.875% convertible notes and $11,000 of financing secured by a mortgage on the Wood Dale, Illinois facility, as well as proceeds from other borrowings of $3,701. Reductions in borrowings during fiscal 2004 were $94,615. During the twelve-month period ended May 31, 2004, we retired 71/4% Notes in the amount of $22,600 which matured on October, 15, 2003, repaid $24,000 outstanding under the Merrill Lynch secured credit facility, repaid $16,900 of 8.0% notes prior to their maturity, retired $21,291 of notes payable due in June 2005, retired $5,630 of notes payable due in December 2007 and reduced other borrowings by $4,194.


Contractual Obligations and Off-Balance Sheet Arrangements

        A summary of contractual obligations and off-balance sheet arrangements as of May 31, 2004 is as follows:

 
 Payments Due by Period
 
 Total
 Due in
Fiscal
2005

 Due in
Fiscal
2006

 Due in
Fiscal
2007

 Due in
Fiscal
2008

 Due in
Fiscal
2009

 After
Fiscal
2009

On Balance Sheet:                     
 Debt $218,194 $760 $792 $831 $75,241 $8,820 $131,750
 
Non-recourse Debt

 

 

31,968

 

 

736

 

 

31,232

 

 


 

 


 

 


 

 

 
Bank Borrowings

 

 

1,896

 

 

1,896

 

 


 

 


 

 


 

 


 

 


Off Balance Sheet:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
 Aviation Equipment                     
  Operating Leases  31,696  10,471  6,783  14,442      
 
Facilities and Equipment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Operating Leases  16,925  4,548  3,832  3,376  2,457  2,000  712
 
Garden City Operating Lease

 

 

33,137

 

 

1,354

 

 

1,388

 

 

1,423

 

 

1,458

 

 

1,495

 

 

26,019
 
Purchase Obligations

 

 

47,424

 

 

46,030

 

 

1,394

 

 


 

 


 

 


 

 

        We routinely issue letters of credit and performance bonds in the ordinary course of business. These instruments are typically issued in conjunction with insurance contracts or other business requirements. The total of these instruments outstanding at May 31, 2004 was approximately $10,952.

Critical Accounting Policies and Significant Estimates

        Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States. Management has made estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities to prepare the consolidated financial statements. The most significant estimates made by management include adjustments to reduce the value of inventories and equipment on or available for lease, allowance for doubtful accounts and loss accruals for aviation equipment operating leases. Accordingly, actual results could differ materially from those estimates. The following is a summary of the accounting policies considered critical by management.

        Allowance for Doubtful Accounts    Our allowance for doubtful accounts is intended to reduce the value of customer accounts receivable to amounts expected to be collected. In determining the required allowance, we consider factors such as general and industry-specific economic conditions, customer credit history, and the customer's current and expected future financial performance.

        Inventories    Inventories are valued at the lower of cost or market. Cost is determined by the specific identification, average cost or first-in, first-out methods. Provisions are made for excess and obsolete inventories and inventories that have been impaired as a result of industry conditions. We have utilized certain assumptions when determining the market value of inventories, such as historical sales of inventory, current and expected future aviation usage trends, replacement values and expected future demand. Principally as a result of the terrorist attacks of September 11, 2001 and its anticipated impact on the global airline industry's financial condition, fleet size and aircraft utilization, we recorded a significant charge for impaired inventories during the second quarter of fiscal 2002 utilizing those assumptions. During the fourth quarter of fiscal 2003, we recorded an additional charge as a result of a further decline in market value for these inventories. Reductions in demand for certain of our inventories or declining market



values, as well as differences between actual results and the assumptions utilized by us when determining the market value of our inventories, could result in additional impairment charges in future periods.

        Equipment on or Available for Lease    Lease revenue is recognized as earned. The cost of the asset under lease is original purchase price plus overhaul costs. Depreciation is computed using the straight-line method over the estimated service life of the equipment, and maintenance costs are expensed as incurred. The balance sheet classification is based on the lease term, with fixed-term leases less than twelve months classified as short-term and all others classified as long-term.

        In accordance with Statement of Financial Accounting Standards No. 144 (SFAS No. 144), "Accounting for the Impairment or Disposal of Long-lived Assets", we are required to test for impairment of long-lived assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable from its undiscounted cash flows. When applying the provisions of SFAS No. 144 to equipment on or available for lease, we have utilized certain assumptions when estimating future undiscounted cash flows, including current and future lease rates, lease terms, residual values and market conditions and trends impacting future demand. Differences between actual results and the assumptions utilized by us when determining undiscounted cash flows could result in future impairments of equipment on or available for lease.

        Aviation Equipment Operating Leases    From time to time we lease aviation equipment (engines and aircraft) from lessors under arrangements that are classified by us as operating leases. We may also sublease the aviation equipment to a customer on a short- or long-term basis. The terms of the operating leases in which we are the lessee are one year with options to renew annually at our election. If we elect not to renew a lease or the lease term expires, we will purchase the equipment from the lessor at its scheduled purchase option price. The terms of the lease agreements also allow us to purchase the equipment at any time during a lease at its scheduled purchase option price. In those instances in which we anticipate that we will purchase aviation equipment and that the scheduled purchase option price will exceed estimated undiscounted cash flows related to the equipment, we record an accrual for loss. We have utilized certain assumptions when estimating future undiscounted cash flows, such as current and future lease rates, residual values and market conditions and trends impacting future demand. Differences between actual results and the assumptions utilized by us when determining undiscounted cash flows could result in future provisions for losses on aviation equipment under operating leases.

Forward-Looking Statements

        Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations containscontain certain statements relating to future results, which are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on the beliefs of management, as well as assumptions and estimates based on information available to us as of the dates such assumptions and estimates are made, and are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated, depending on a variety of factors, including those factors discussed under this Item 7 entitled "Factors Which May Affect Future Results"1A, “Risk Factors”. Should one or more of those risks or uncertainties materialize adversely, or should underlying assumptions or estimates prove incorrect, actual results may vary materially from those described. Those events and uncertainties are difficult or impossible to predict accurately and many are beyond our control. We assume no obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

General Overview

We report our activities in four business segments: Aviation Supply Chain; Maintenance, Repair and Overhaul; Structures and Systems; and Aircraft Sales and Leasing.

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 to the commercial aviation and defense markets, as well as the repair and overhaul of a wide range of commercial and military aircraft airframe parts. We also provide customized inventory supply and management programs and performance-based logistics programs for engine and airframe parts and components. Sales also include the sale and lease of commercial jet engines. Cost of sales consists principally of the cost of product (primarily aircraft and engine parts), direct labor and overhead (primarily indirect labor, facility cost and insurance).

Sales in the Maintenance, Repair and Overhaul segment are principally derived from aircraft maintenance and storage and the repair and overhaul of most commercial landing gear types. 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 manufacture and sale of containers, pallets and shelters used to support the U.S. military’s tactical deployment requirements, 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.

Sales in the Aircraft Sales and Leasing segment are derived from the sale and lease of commercial aircraft and technical and advisory services. Cost of sales consists principally of the cost of product (aircraft), labor and the cost of lease revenue (primarily depreciation, lease expense and insurance).


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 tables below set forth consolidated sales and gross profit for our four business segments for each of the last three fiscal years ended May 31.

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Sales:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

543,674

 

$

461,166

 

$

390,060

 

Maintenance, Repair and Overhaul

 

211,516

 

182,258

 

111,932

 

Structures and Systems

 

264,083

 

228,747

 

193,296

 

Aircraft Sales and Leasing

 

41,896

 

13,347

 

45,139

 

 

 

$

1,061,169

 

$

885,518

 

$

740,427

 

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Gross Profit:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

114,383

 

$

99,255

 

$

67,672

 

Maintenance, Repair and Overhaul

 

29,915

 

25,914

 

14,414

 

Structures and Systems

 

36,021

 

33,711

 

35,184

 

Aircraft Sales and Leasing

 

3,828

 

4,341

 

3,305

 

 

 

$

184,147

 

$

163,221

 

$

120,575

 

Business Trends and Highlights

During calendar year 2006 and into the first quarter of 2007, many of the domestic commercial airlines reported improved financial results, reflecting their ability to implement fare increases to partially offset the continued high cost of fuel and intense competition. The improvement has also been driven by the airlines’ continued focus on controlling non-fuel related expenses, the implementation of operational efficiencies and relatively high load factors. We expect certain carriers will continue to aggressively seek ways to reduce their cost structure, including outsourcing more of their maintenance and support functions to third parties. Further, low-cost carriers continue to expand their presence around the world. Many of these low-cost carriers are flying newer aircraft which will result in increasing demand for maintenance and parts support in future years. We believe we remain well positioned to respond to the market with our broad range of products and services as these trends continue to develop.

We continue to experience strong demand for performance-based logistic services and mobility products supporting our defense customers’ deployment activities. We are monitoring the debate between the current Administration and the U.S. Congress regarding the troop withdrawal from Iraq and its impact on demand for our products and services. Although it remains difficult for us to predict long-term demand for these types of products and services, we believe we are well positioned with our current portfolio of products and services and growth plans to benefit from longer-term U.S. military deployment and program management strategies.

Results of Operations

Fiscal 2007 Compared with Fiscal 2006

(as compared with the same period of the prior year)

Consolidated sales for fiscal 2007 increased $175,651 or 19.8% over the prior year. Each reporting segment experienced sales growth with sales to commercial customers increasing 24.3% and sales to defense customers up 14.4% compared to the prior year. The sales increase to commercial customers


reflects the improved commercial airline environment, our expanded presence in global markets, growth in supply chain programs, and increased demand for airframe maintenance and landing gear overhaul services. Sales to defense customers increased as we continue to experience strong demand for performance-based logistics programs and specialized mobility products and the impact from acquisitions.

Sales in the Aviation Supply Chain segment increased $82,508 or 17.9% over the prior year. The sales increase reflects strong demand for engine and airframe parts from commercial customers due to improved sourcing and program execution as well as the implementation of new supply chain programs. The increase in sales to defense customers was driven by continued strong demand for parts support from performance-based logistics programs. Gross profit in the Aviation Supply Chain segment increased $15,128 or 15.2% over the prior year primarily due to increased sales volume, partially offset by an impairment charge of $4,750 recorded in this segment during the first quarter of fiscal 2007 (see Note 13 of Notes to Consolidated Financial Statements). The gross profit margin percentage decreased slightly to 21.0% from 21.5% in the prior year due to the unfavorable mix of products sold and the impairment charge.

In the Maintenance, Repair and Overhaul segment, sales increased $29,258 or 16.1% over the prior year. The increase in sales is primarily attributable to increased demand for landing gear overhaul services as well as airframe maintenance at our Oklahoma and Indianapolis airframe maintenance facilities. Gross profit in the Maintenance, Repair and Overhaul segment increased $4,001 or 15.4% over the prior year due to the increase in sales and the gross profit margin percentage decreased slightly to 14.1% from 14.2%. The gross profit margin improved at our landing gear and Oklahoma airframe maintenance businesses due to increased sales and operational efficiencies. The gross profit margin declined at our Indianapolis airframe maintenance facility due to start-up inefficiencies associated with new customers.

In the Structures and Systems segment, sales increased $35,336 or 15.4% over the prior year. The increase in sales was primarily due to the development and delivery of increasingly complex and specialized shelter products and higher volume of pallets at our Mobility Systems business. Sales also increased due to the inclusion of $12,368 of revenue from Brown which was acquired during the fourth quarter of fiscal 2007 (see Note 11 of Notes to Consolidated Financial Statements). Sales of our cargo systems were lower as we relocated production to a new manufacturing facility in North Carolina. Gross profit in the Structures and Systems segment increased $2,310 or 6.9% compared to the prior year due to the increase in sales. The gross profit margin percentage decreased from 14.7% to 13.6% due to the unfavorable mix of products sold, primarily at our Mobility Systems business.

In the Aircraft Sales and Leasing segment, sales increased $28,549 due to more aircraft sales compared to the prior year. During fiscal 2007, our joint ventures purchased six aircraft and sold ten. The increase in earnings from aircraft joint ventures compared to the prior year is primarily due to the sale of the ten aircraft. At May 31, 2007, the total number of aircraft held in joint ventures was 12 (see Note 7 of Notes to Consolidated Financial Statements). Our strategy in the Aircraft Sales and Leasing segment is to build an aircraft portfolio through participation in joint ventures and for our own account. We also own nine aircraft outside of the joint ventures. Of the nine aircraft owned by us outside the aircraft joint ventures, five were acquired prior to September 11, 2001. Gross profit in the Aircraft Sales and Leasing segment decreased $513 compared to the prior year principally due to the impairment charge of $2,902 recorded during the first quarter of fiscal 2007 (see Note 13 of Notes to Consolidated Financial Statements).

In the first quarter of fiscal 2007, we recorded an impairment charge of $4,750 in the Aviation Supply Chain segment for engine parts that were acquired prior to September 11, 2001, and were subject to impairment charges recorded in prior years. This impairment charge was triggered by our decision to aggressively pursue the liquidation of this inventory. We made this decision to recognize the impairment due to the impact of persistently high fuel costs and fewer operators on demand for these parts, as well as


to better align human and physical resources with higher potential opportunities in the rapidly growing Aviation Supply Chain segment (see Note 13 of Notes to Consolidated Financial Statements). In the Aircraft Sales and Leasing segment, we recorded an impairment charge of $2,902 during the first quarter of 2007 on a wide-body aircraft originally purchased prior to September 11, 2001. The lease and non-recourse debt on the aircraft were restructured during the quarter, and we made the decision to offer the aircraft for sale and recorded the impairment charge to reduce the carrying value of the aircraft to estimated net realizable value. As part of the restructuring, the lender of the non-recourse debt reduced the outstanding principal balance by $2,927 which resulted in a gain on extinguishment of the same amount.

During the first quarter of fiscal 2007, we sold substantially all assets, subject to certain liabilities, of a product line within our Structures and Systems segment. Proceeds from the sale of the product line were $6,567 and the net carrying value of the assets sold was $1,209, resulting in a gain on sale of product line of $5,358. The gain on this transaction has been classified as a component of operating income in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.

Operating income increased $30,194 or 46.3% compared with the prior year’s period due to increased sales, increased earnings from aircraft joint ventures and the gain on the sale of a product line, partially offset by impairment charges and an increase in selling, general and administrative expenses. In fiscal 2007, our selling, general and administrative expenses increased $5,540 or 5.6% over the prior year primarily due to increased resources to support our growth. Selling, general and administrative expenses as a percentage of sales decreased to 9.9% compared to 11.2% in the prior year. Interest expense decreased $1,303 or 7.2% primarily due to a reduction in average outstanding borrowings on our revolving credit agreements during fiscal 2007, as well as capitalized interest of $977. Interest income and other increased $2,593 or 80.1% due to higher average invested cash during the current fiscal year, as well as a $915 gain on sale of an equity security. Our effective income tax rate for fiscal 2007 was 32.0% compared to 23.0% in the prior year due to lower tax benefits on export activities. We expect our effective income tax rate to be approximately 35% in fiscal 2008.

During the third quarter of fiscal 2007, we decided to exit our non-core industrial turbine business, which was part of the Structures and Systems segment, and classified the results as a discontinued operation. Sales for this business were $7,778 in fiscal 2007.

Net income increased to $58,660 for fiscal 2007 compared to $35,163 in the prior year due to the factors discussed above.

Fiscal 2006 Compared with Fiscal 2005

Consolidated sales for fiscal 2006 increased $145,091 or 19.6% over the prior year. The increase in sales over the prior year was attributable to sales increases in the Aviation Supply Chain; Maintenance, Repair and Overhaul and Structures and Systems segments due to an 18.8% increase in sales to commercial airline customers and a 21.7% increase in sales to defense customers. The increase in sales to commercial airline customers principally reflects improved demand for engine and airframe parts support due to increased passenger traffic, improved sourcing and program execution. Sales to commercial customers also increased as a result of a full year of revenue during fiscal 2006 at the Indianapolis airframe maintenance facility, compared to only four full months during fiscal 2005, as that facility commenced operations in January 2005. The increase in sales to defense customers was principally driven by continued strong demand for specialized mobility products and new performance-based logistics programs. Consolidated gross profit increased $42,646 or 35.4% over the prior year. The increase in gross profit was attributable to the consolidated sales increase, as well as an improvement in the consolidated gross margin percentage to 18.4% from 16.3% in the prior year.


Sales in the Aviation Supply Chain segment increased $71,106 or 18.2% compared to the prior year. The sales increase reflects increased demand for engine and airframe parts to commercial customers as well as an increase in sales to program customers using our supply chain management programs. The increase in sales to defense customers served by this segment was driven by continued strong demand for parts support from existing and new performance-based logistics programs. Gross profit in the Aviation Supply Chain segment increased $31,583 or 46.7% over the prior year primarily due to increased sales volume as well as an improvement in the gross profit margin percentage to 21.5% from 17.3% in the prior year. The improvement in the gross profit margin percentage was attributable to effective purchasing and favorable mix of products sold.

In the Maintenance, Repair and Overhaul segment, sales increased $70,326 or 62.8% over the prior year. The increase in sales was primarily attributable to a full year of revenue at our Indianapolis airframe maintenance facility during fiscal 2006, compared with only four full months of sales during fiscal 2005, as that facility commenced operations in January 2005. Sales also increased over the prior year at our Oklahoma City airframe maintenance facility and landing gear overhaul center reflecting stronger demand. Gross profit in the Maintenance, Repair and Overhaul segment increased $11,500 or 79.8% over the prior year and the gross profit margin percentage improved from 12.9% to 14.2%, primarily due to improvements at our Oklahoma City-based airframe maintenance facility and the favorable impact of a full year of operations at the Indianapolis airframe maintenance facility.

In the Structures and Systems segment, sales increased $35,451 or 18.3% over the prior year as we experienced increased sales at all of our business units within the segment. The increase was primarily attributable to increased sales of products supporting our defense customers’ deployment activities due to continued strong demand and new product development, and increased demand for cargo systems and composite structure products primarily due to successful sales and marketing efforts. Gross profit in the Structures and Systems segment declined $1,473 or 4.2% compared to the prior year as the gross profit margin percentage decreased from 18.2% to 14.7% primarily due to the unfavorable mix of products sold.

In the Aircraft Sales and Leasing segment, sales decreased $31,792 or 70.4% compared with the prior year. The decrease in sales is principally due to the fact that the majority of current year aircraft activity is conducted through unconsolidated joint ventures, which excludes revenues from consolidated net sales. Since September 11, 2001, most of the aircraft transactions we have entered into have been with joint venture partners who provide equity capital equal to our equity capital contribution. Debt is provided on a limited recourse basis by various financial institutions. Gross profit in the Aircraft Sales and Leasing segment increased $1,036 or 31.3% compared to the prior year.

Operating income increased $30,255 or 86.6% compared with the prior year due to increased gross profit, partially offset by an increase in selling, general and administrative expenses. During fiscal 2006, selling, general and administrative expenses increased $13,325 or 15.5% primarily due to increased resources to support our growth. Net interest expense declined $647 compared to the prior year primarily due to increased interest income as a result of higher average invested cash balances during fiscal 2006 compared with the prior year.

During the third quarter of fiscal 2006, we acquired $50,645 aggregate principal amount of our 2.875% Convertible Senior Notes due 2024, or approximately 76% of the previously outstanding principal amount, in exchange for an aggregate 2,724 newly issued shares of common stock plus $3,893 in cash, in privately negotiated transactions exempt from the registration requirements under the Securities Act of 1933, as amended. The number of shares issued was equivalent to the number into which the notes were convertible under the original terms of the notes. We recorded $3,893 of pre-tax expense on the exchange of the notes into stock in advance of the call date which was comprised of interest that the note holders would otherwise have been entitled to receive as well as an incentive payment made as part of the exchange.


Also during the third quarter of fiscal 2006, upon completion of our fiscal 2005 Federal income tax return, we determined that the Company qualified for additional tax benefits of $1,606 related to higher than estimated margin on fiscal 2005 export activities. We recorded a benefit of $496 related to fiscal 2004 export activity in the third quarter of 2005. Our effective income tax rate for fiscal 2006 was 23.0% compared to 15.5% in the prior year.

Income from continuing operations increased to $35,823 compared to $19,498 in the prior year due to the factors discussed above.

During the third quarter of fiscal 2005, we sold our engine component repair business located in Windsor, Connecticut, and during the third quarter of fiscal 2007, we decided to exit our non-core industrial turbine business. As a result, we have classified the results of these businesses as discontinued operations for all periods presented.

Net income increased to $35,163 for fiscal 2006 compared to $15,453 in the prior year due to the factors discussed above.

Legal Matters

AAR Manufacturing, Inc., a subsidiary of the Company (“subsidiary”) received an Administrative Order for Response Activity (“Order”) dated August 7, 2003, from the Michigan Department of Environmental Quality (“MDEQ”) relating to environmental conditions at and in the vicinity of the subsidiary’s Cadillac, Michigan plant. The Order requires the subsidiary to perform environmental investigatory work, prepare a feasibility study and a remedial action plan, and perform interim response actions. The interim response actions include continuation of the response activities the subsidiary is performing under a 1985 Consent Decree, operation of a soil vapor extraction system the subsidiary had previously installed and operated, determination of the need to provide alternate water supplies to off-site properties (and if it is so determined then to actually provide them), removal of any free phase liquids encountered in the ground, providing notices of groundwater contamination migration to off-site property owners, and other actions determined by the MDEQ or the subsidiary to be appropriate. The MDEQ further demands payment of environmental response costs already incurred by the MDEQ in the approximate amount of $2,500 plus interest, and reimbursement of unspecified costs to be incurred in the future by the MDEQ. The Order and the letter accompanying it threaten the imposition of civil fines up to $25 for each day of violation of the Order, plus exemplary damages up to three times the costs incurred by the MDEQ if the subsidiary does not comply with the Order. The Order may require the implementation of the remedial action plan, although it is not clear on that point. The Order requires the implementation of emergency response action if a release of hazardous substances, threat of a release, or exacerbation of existing contamination occurs during the pendency of the Order.

The subsidiary advised the MDEQ that it would perform the requirements of the Order to the extent those requirements apply to the allegation by the MDEQ that a release of hazardous substances occurred after the execution of the 1985 Consent Decree. The subsidiary declined to perform certain work required by the Order that the subsidiary believes is based on claims resolved in the 1985 Consent Decree. The MDEQ responded to the subsidiary by saying that the MDEQ “will be taking appropriate action to protect public health, safety and welfare and the environment, and gain AAR’s compliance with Part 201” (the Michigan “cleanup law”).

The subsidiary has received funds from an insurance carrier to reimburse it for a portion of the subsidiary’s costs. The subsidiary sought coverage from another insurance company and that carrier is paying a portion of defense costs, but has reserved its rights on coverage for the litigation noted below. The subsidiary has filed suit against one of the insurance carriers for breach of contract and other relief and recently reached a settlement.


Prior to the issuance of the Order, the subsidiary sought a Court order to enforce the 1985 Consent Decree, but that relief was denied by the Court, primarily on the basis that the action was premature since the State was not pursuing an enforcement action at the time. The subsidiary sought leave to appeal that decision to the Michigan Court of Appeals, but leave was denied.

The work performed and data gathered by the subsidiary since the issuance of the Order appears to support the positions previously taken by the subsidiary regarding the movement of groundwater for treatment by the subsidiary. There is disagreement with the MDEQ regarding the conclusions to be drawn from the data developed from that work. The MDEQ has retained contractors to perform environmental investigations in the vicinity of the plant.

On March 31, 2005, a complaint was filed by the MDEQ in Cadillac, Michigan with the Wexford County Circuit Court. The case is Michigan Department of Environmental Quality v AAR Cadillac Manufacturing, a division of AAR Manufacturing Group, Inc., an Illinois corporation, and AAR Corp., a Delaware corporation, File No. 05-18853-CE. In its complaint, the MDEQ seeks to enforce the Order against the subsidiary and to have the Court impose civil fines and exemplary damages upon the subsidiary for the alleged failure to comply with the Order. The MDEQ seeks to recover its costs incurred in performing response activities from both the subsidiary and the Company and seeks a declaratory judgment that both are liable for all future costs incurred by the State at the facility. The MDEQ also seeks civil fines from the subsidiary for alleged violations of a particular section of a Michigan environmental law.

The Company and the subsidiary filed their Answer, including Affirmative Defenses, and intend on vigorously defending the complaint filed by the MDEQ. On June 17, 2005, the subsidiary also filed a Petition for Reimbursement of its costs in the amount of approximately $200 incurred in complying with the Order from the State of Michigan cleanup and redevelopment fund established under Michigan law, plus costs and attorney fees. As of May 31, 2007, the subsidiary has charged to operations $1,309 related to this matter. The MDEQ has filed a motion for summary disposition which is scheduled for an August 20, 2007 hearing.

In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial condition or results of operations.

Liquidity and Capital Resources

Historically, we have funded our operating activities and met our commitments through the generation of cash from operations, augmented by the periodic issuance of common stock and debt in the public and private markets. In addition to these cash sources, our capital resources include our unsecured credit facility. Our ability to borrow from our lenders and issue debt and equity securities to the public and private markets in the future may be negatively affected by a number of factors, including general economic conditions, airline and aviation industry conditions, geo-political events, including the war on terrorism, and our operating performance. Our ability to generate cash from operations is influenced primarily by our operating performance and changes in working capital. We have a universal shelf registration on file with the Securities and Exchange Commission under which, subject to market conditions, up to $163,675 of common stock, preferred stock or medium- or long-term debt securities may be issued or sold.

At May 31, 2007, our liquidity and capital resources included cash of $83,317 and working capital of $389,215. On August 31, 2006, we entered into a credit agreement with various financial institutions, as lenders, and LaSalle Bank National Association, as administrative agent for the lenders (the “LaSalle Credit Agreement”). The LaSalle Credit Agreement created a $140,000 unsecured revolving credit facility that we can draw upon for general corporate purposes. Under certain circumstances, we may request an increase to the revolving commitment by an aggregate amount of up to $35,000, not to exceed $175,000 in


total.  The LaSalle Credit Agreement expires on August 31, 2010. Borrowings under the LaSalle Credit Agreement bear interest at the London Interbank Offered Rate (“LIBOR”) plus 125 to 200 basis points based on certain financial measurements. There were no borrowings outstanding under this facility at May 31, 2007. On August 31, 2006, we terminated our secured revolving credit agreement with Merrill Lynch Capital and during the second quarter of fiscal 2007, we terminated our accounts receivable securitization program. No borrowings were outstanding and no accounts receivable were sold at the date of these terminations. No material penalties or fees resulted from the terminations. In addition to our domestic facility, we also have $3,041 available under a foreign line of credit.

We continually evaluate various financing arrangements, including the issuance of common stock or debt, that would allow us to improve our liquidity position and finance future growth on commercially reasonable terms. Our ability to obtain additional financing is dependent upon a number of factors, including the geo-political environment, general economic conditions, airline industry conditions, our operating performance and market conditions in the public and private debt and equity markets.

During the year ended May 31, 2007, we used $21,239 of cash from operations primarily due to investments of $67,750 made in aircraft and engines on both short- and long-term lease, a $25,160 increase in accounts receivable reflecting higher sales, payment of capitalized program development costs of $17,023 related to the A400M program which is reported in other on the consolidated statements of cash flows, and investment in inventories of $8,567. During fiscal 2007, cash flow from operations benefited from an increase in accounts payable of $6,473 as well as net income and depreciation and amortization of $90,859.

During the year ended May 31, 2007, our investing activities used $39,129 of cash, principally as a result of capital expenditures of $29,891, acquisitions of $38,478 (see Note 11 of Notes to Consolidated Financial Statements) and investment in aircraft joint ventures of $9,556, partially offset by cash generated from the sales of our interests in aircraft joint ventures of $32,108 and proceeds from the sale of a product line of $6,567 (see Note 12 of Notes to Consolidated Financial Statements).

During the year ended May 31, 2007, cash generated from financing activities was $21,973, comprised principally of proceeds from borrowings related to aircraft financings of $30,355, cash proceeds from stock option exercises of $8,576 and excess tax benefits from the exercise of stock options of $4,345, partially offset by a reduction in borrowings of $20,439, which includes $9,034 for the early retirement of 6.875% Notes due December 15, 2007.


Contractual Obligations and Off-Balance Sheet Arrangements

A summary of contractual obligations and off-balance sheet arrangements as of May 31, 2007 is as follows:

 

 

Payments Due by Period

 

 

 

 

 

Due in

 

Due in

 

Due in

 

Due in

 

Due in

 

After

 

 

 

 

 

Fiscal

 

Fiscal

 

Fiscal

 

Fiscal

 

Fiscal

 

Fiscal

 

 

 

Total

 

2008

 

2009

 

2010

 

2011

 

2012

 

2012

 

On Balance Sheet:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt

 

$

284,229

 

$

51,366

 

$

200

 

$

200

 

$

55,108

 

$

 

$

177,355

 

Non-recourse Debt

 

43,627

 

22,879

 

640

 

696

 

757

 

823

 

17,832

 

Interest

 

87,679

 

13,562

 

9,243

 

9,008

 

8,492

 

3,916

 

43,458

 

Off Balance Sheet:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Aviation Equipment Operating Leases

 

8,960

 

3,840

 

3,840

 

1,280

 

 

 

 

Facilities and Equipment Operating Leases

 

32,506

 

7,971

 

6,893

 

5,581

 

4,122

 

3,740

 

4,199

 

Garden City Operating Lease

 

29,092

 

1,455

 

1,492

 

1,529

 

1,567

 

1,606

 

21,443

 

Purchase Obligations

 

106,783

 

103,535

 

3,248

 

 

 

 

 

Pension Contribution

 

4,000

 

4,000

 

 

 

 

 

 

Purchase obligations arise in the ordinary course of business and represent a binding commitment to acquire inventory, including raw materials, parts and components, as well as equipment to support the operations of our business. We routinely issue letters of credit and performance bonds in the ordinary course of business. These instruments are typically issued in conjunction with insurance contracts or other business requirements. The total of these instruments outstanding at May 31, 2007 was approximately $11,891.

Critical Accounting Policies and Significant Estimates

Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States. Management has made estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities to prepare the consolidated financial statements. The most significant estimates made by management include adjustments to reduce the value of inventories and equipment on or available for lease, allowance for doubtful accounts, revenue recognition, loss accruals for aviation equipment operating leases and assumptions used in determining pension plan obligations. Accordingly, actual results could differ materially from those estimates. The following is a summary of the accounting policies considered critical by management.

Allowance for Doubtful Accounts

Our allowance for doubtful accounts is intended to reduce the value of customer accounts receivable to amounts expected to be collected. In determining the required allowance, we consider factors such as general and industry-specific economic conditions, customer credit history, and the customer’s current and expected future financial performance.

Inventories

Inventories are valued at the lower of cost or market. Cost is determined by the specific identification, average cost or first-in, first-out methods. Provisions are made for excess and obsolete inventories and inventories that have been impaired as a result of industry conditions. We have utilized certain


assumptions when determining the market value of inventories, such as historical sales of inventory, current and expected future aviation usage trends, replacement values and expected future demand. During the first quarter of fiscal 2007, we recorded an impairment charge related to certain engine parts in the amount of $4,750. These parts were acquired prior to September 11, 2001, and were subject to impairment charges recorded in fiscal 2002 and 2003. The fiscal 2007 impairment charge was triggered by the Company’s decision to aggressively pursue the liquidation of this inventory. The Company made this decision to recognize the impairment due to the impact of persistently high fuel costs and fewer operators on demand for these parts, as well as to better align human and physical resources with higher potential opportunities in the rapidly growing Aviation Supply Chain segment. Reductions in demand for certain of our inventories or declining market values, as well as differences between actual results and the assumptions utilized by us when determining the market value of our inventories, could result in additional impairment charges in future periods.

Revenue Recognition

Certain supply chain management programs that 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 connection with these programs, we are required to make certain judgments and estimates concerning the overall profitability of the program and the relative fair value of each element of the arrangement. Differences may occur between the judgments and estimates made by management and actual program results.

Equipment on or Available for Lease

The cost of assets under lease is original purchase price plus overhaul costs. Depreciation is computed using the straight-line method over the estimated service life of the equipment, and maintenance costs are expensed as incurred.

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, we are required to test for impairment of long-lived assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable from its undiscounted cash flows. When applying the provisions of SFAS No. 144 to equipment on or available for lease, we have utilized certain assumptions to estimate future undiscounted cash flows, including current and future lease rates, lease terms, residual values and market conditions and trends impacting future demand. Differences between actual results and the assumptions utilized by us when determining undiscounted cash flows could result in future impairments of aircraft and engines which are currently being leased or are available for lease.

Pension Plans

The liabilities and net periodic cost of our pension plans are determined utilizing several actuarial assumptions, the most significant of which are the discount rate and the expected long-term rate of return on plan assets.

Our discount rate is determined based on a review of long-term, high quality corporate bonds as of May 31, 2007 and models that match projected benefit payments to coupons and maturities from the high quality bonds. The assumption for the expected long-term return on plan assets is developed through analysis of historical asset returns by investment category, our fund’s actual return experience and current market conditions. Changes in the discount rate and differences between expected and actual return on


plan assets may impact the amount of net periodic pension expense recognized in our consolidated statement of operations.

New Accounting Standards

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 provides guidance regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether financial statement restatement is necessary. SAB 108 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. The adoption of SAB 108 did not have a material impact on our results of operations or financial position.

In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48 (FIN No. 48), “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.”  FIN No. 48 clarifies the recognition threshold and measurement requirements for tax positions taken or expected to be taken in tax returns and provides guidance on the related classification and disclosure. The provisions of FIN No. 48 are effective for fiscal years beginning after December 15, 2006. Accordingly, we will adopt FIN No. 48 no later than the beginning of fiscal year 2008. FIN No. 48 will not have a material impact on our results from operations or financial position.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS No. 157 establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We have not yet determined the impact of the adoption of this new accounting standard.

ITEM 7A.        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

(Dollars in thousands)

Our exposure to market risk includes fluctuating interest rates under our credit agreements, foreign exchange rates and accounts receivable. See Part II, Item 8 for a discussion on accounts receivable exposure. During fiscal 20042007, 2006 and 2003,2005, we did not utilize derivative financial instruments to offset these risks.

At May 31, 2004, $22,4492007, $140,000 was available under our secured revolving credit facility with Merrill Lynch Capital.LaSalle Credit Agreement. Interest on amounts borrowed under this credit facility is LIBOR based. As of May 31, 2004,2007, the outstanding balance under this agreement was $0. A hypothetical 10 percent increase to the average interest rate under the credit facilities applied to the average outstanding balance during fiscal 20042007 would not have reducedhad an impact on our pre-tax income by approximately $31results of operations as we had no borrowings outstanding under this agreement during fiscal 2004.2007.

Revenues and expenses of our foreign operations are translated at average exchange rates during the period,year, and balance sheet accounts are translated at period-endyear-end exchange rates. Balance sheet translation adjustments are excluded from the results of operations and are recorded in stockholders'stockholders’ equity as a component of accumulated other comprehensive income (loss). A hypothetical 10 percent devaluation of foreign currencies against the U.S. dollar would not have had a material impact on our financial position or results of operations.

25






ITEM 8.              FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm

TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF AAR CORP.:

We have audited the accompanying consolidated balance sheets of AAR CORP. and subsidiaries (the Company) as of May 31, 20042007 and 20032006 and the related consolidated statements of operations, stockholders'stockholders’ equity and cash flows for each of the years in the three-year period ended May 31, 2004.2007. These consolidated financial statements are the responsibility of the Company'sCompany’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AAR CORP. and subsidiaries as of May 31, 20042007 and 2003,2006 and the results of their operations and their cash flows for each of the years in the three-year period ended May 31, 2004,2007, in conformity with accounting principlesU.S. generally accepted accounting principles.

We also have audited, in accordance with the United Statesstandards of America.
the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of May 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated July 19, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

                        KPMG LLP

Chicago, Illinois
June 28, 2004


(This page has been left blank intentionally.)


July 19, 2007

26




AAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

 
 For the Year Ended May 31,
 
 
 2004
 2003
 2002
 
 
 (In thousands except per share data)

 
Sales:          
 Sales from products and leasing $554,079 $519,370 $557,813 
 Sales from services  97,879  86,967  80,908 
  
 
 
 
   651,958  606,337  638,721 
  
 
 
 
Costs and operating expenses:          
 Costs of products and leasing  469,930  448,705  480,415 
 Cost of services  81,321  75,214  68,558 
 Cost of sales-impairment charge    5,360  75,900 
 Selling, general and administrative and other  81,929  78,845  85,037 
 Special charges      10,100 
  
 
 
 
    633,180  608,124  720,010 
Operating income (loss)  18,778  (1,787) (81,289)
Interest expense  (18,819) (19,539) (19,798)
Interest income  1,748  1,836  2,858 
  
 
 
 
Income (loss) before provision for income taxes  1,707  (19,490) (98,229)
Income tax benefit  (1,797) (7,080) (39,290)
  
 
 
 
Net income (loss) $3,504 $(12,410)$(58,939)
  
 
 
 
Earnings (loss) per share of common stock — basic $0.11 $(0.39)$(2.08)
  
 
 
 
Earnings (loss) per share of common stock — diluted $0.11 $(0.39)$(2.08)
  
 
 
 

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

 

 

(In thousands except per share data)

 

Sales:

 

 

 

 

 

 

 

Sales from products.

 

$

882,509

 

$

732,908

 

$

629,054

 

Sales from services.

 

150,400

 

128,182

 

90,021

 

Sales from leasing

 

28,260

 

24,428

 

21,352

 

 

 

1,061,169

 

885,518

 

740,427

 

Cost and operating expenses:

 

 

 

 

 

 

 

Cost of products

 

724,419

 

603,643

 

533,271

 

Cost of services

 

126,372

 

102,709

 

67,523

 

Cost of leasing

 

18,579

 

15,945

 

19,058

 

Cost of sales-impairment charges

 

7,652

 

 

 

Selling, general and administrative and other

 

105,091

 

99,551

 

86,226

 

 

 

982,113

 

821,848

 

706,078

 

Gain on sale of product line

 

5,358

 

 

 

Earnings from aircraft joint ventures

 

10,952

 

1,502

 

568

 

Operating income

 

95,366

 

65,172

 

34,917

 

Gain (loss) on extinguishment of debt

 

2,927

 

(3,893

)

3,562

 

Interest expense

 

(16,701

)

(18,004

)

(16,917

)

Interest income and other

 

5,829

 

3,236

 

1,502

 

Income before provision for income taxes

 

87,421

 

46,511

 

23,064

 

Provision for income taxes

 

27,974

 

10,688

 

3,566

 

Income from continuing operations

 

59,447

 

35,823

 

19,498

 

Discontinued operations, net of tax:

 

 

 

 

 

 

 

Operating loss

 

(787

)

(660

)

(1,724

)

Loss on disposal

 

 

 

(2,321

)

Loss from discontinued operations

 

(787

)

(660

)

(4,045

)

Net income

 

$

58,660

 

$

35,163

 

$

15,453

 

Earnings per share—basic:

 

 

 

 

 

 

 

Earnings from continuing operations

 

$

1.63

 

$

1.07

 

$

0.60

 

Loss from discontinued operations

 

(0.02

)

(0.02

)

(0.12

)

Earnings per share—basic.

 

$

1.61

 

$

1.05

 

$

0.48

 

Earnings per share—diluted:

 

 

 

 

 

 

 

Earnings from continuing operations

 

$

1.42

 

$

0.96

 

$

0.57

 

Loss from discontinued operations

 

(0.02

)

(0.02

)

(0.11

)

Earnings per share—diluted.

 

$

1.40

 

$

0.94

 

$

0.46

 

The accompanying notes to consolidated financial statements
are an integral part of these statements.

27





AAR CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

ASSETS



 May 31,
 

 

May 31,

 



 2004
 2003
 

 

2007

 

2006

 



 (In thousands)

 

 

(In thousands)

 

Current assets:Current assets:     

 

 

 

 

 

Cash and cash equivalents $41,010 $29,154 
Accounts receivable 104,661 66,322 
Inventories 206,899 219,894 
Equipment on or available for short-term lease 40,346 40,060 
Deposits, prepaids and other 11,714 13,692 
Deferred tax assets 27,574 27,290 
 
 
 
 Total current assets 432,204 396,412 
 
 
 

Cash and cash equivalents

 

$

83,317

 

$

121,738

 

Accounts receivable

 

181,691

 

136,272

 

Inventories

 

244,661

 

245,690

 

Equipment on or available for short-term lease

 

97,932

 

77,902

 

Deposits, prepaids and other

 

12,607

 

12,986

 

Deferred tax assets

 

25,513

 

29,866

 

Total current assets.

 

645,721

 

624,454

 

Property, plant and equipment, at cost:Property, plant and equipment, at cost:     

 

 

 

 

 

Land 5,542 6,367 
Buildings and improvements 58,868 68,040 
Equipment, furniture and fixtures 129,793 124,321 
 
 
 

Land

 

4,828

 

4,828

 

Buildings and improvements

 

69,564

 

57,842

 

Equipment, furniture and fixtures.

 

159,313

 

139,863

 

 194,203 198,728 

 

233,705

 

202,533

 

Accumulated depreciationAccumulated depreciation (112,337) (104,699)

 

(145,518

)

(129,896

)

 
 
 

 

88,187

 

72,637

 

Other assets:

 

 

 

 

 

Goodwill and other intangible assets, net

 

74,267

 

44,432

 

Equipment on long-term lease.

 

171,980

 

140,743

 

Investment in joint ventures.

 

17,824

 

28,498

 

Other.

 

69,654

 

68,055

 

 81,866 94,029 

 

333,725

 

281,728

 

 
 
 

 

$

1,067,633

 

$

978,819

 

Other assets:     
Investments in leveraged leases 9,541 27,394 
Goodwill, net 44,421 45,951 
Equipment on long-term lease 84,271 72,732 
Other 56,989 50,103 
 
 
 
 195,222 196,180 
 
 
 
 $709,292 $686,621 
 
 
 

The accompanying notes to consolidated financial statements
are an integral part of these statements.

28





AAR CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

LIABILITIES AND STOCKHOLDERS'STOCKHOLDERS’ EQUITY



 May 31,
 

 

May 31,



 2004
 2003
 

 

2007

 

2006

 



 (In thousands)

 

 

(In thousands)

 

Current liabilities:Current liabilities:     

 

 

 

 

 

Short-term debt $1,896 $24,000 
Current maturities of long-term debt 760 35,729 
Current maturities of non-recourse long-term debt 736 32,527 
Accounts payable 57,582 51,485 
Accrued liabilities 70,287 59,834 
 
 
 
 Total current liabilities 131,261 203,575 
 
 
 

Short-term debt

 

$

 

$

161

 

Current maturities of long-term debt

 

51,366

 

200

 

Current maturities of non-recourse long-term debt

 

22,879

 

1,928

 

Accounts payable

 

110,239

 

97,002

 

Accrued liabilities

 

72,022

 

88,497

 

Total current liabilities

 

256,506

 

187,788

 

Long-term debt, less current maturitiesLong-term debt, less current maturities 217,434 164,658 

 

232,863

 

293,263

 

Non-recourse debtNon-recourse debt 31,232  

 

20,748

 

25,313

 

Deferred tax liabilitiesDeferred tax liabilities 17,628 22,601 

 

40,121

 

25,357

 

Retirement benefit obligation 683 799 
Deferred income and other 9,370  

Other liabilities and deferred income

 

23,152

 

24,381

 

 

316,884

 

368,314

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $1.00 par value, authorized 250 shares; none issued

 

 

 

Common stock, $1.00 par value, authorized 100,000 shares; issued 42,230 and 40,789 shares, respectively.

 

42,230

 

40,789

 

Capital surplus

 

289,673

 

274,211

 

Retained earnings

 

256,052

 

197,392

 

Treasury stock, 4,501 and 4,135 shares at cost, respectively

 

(79,813

)

(69,664

)

Unearned restricted stock awards

 

 

(6,169

)

Accumulated other comprehensive loss.

 

(13,899

)

(13,842

)

 
 
 

 

494,243

 

422,717

 

 276,347 188,058 

 

$

1,067,633

 

$

978,819

 

 
 
 
Stockholders' equity:     
Preferred stock, $1.00 par value, authorized 250 shares; none issued   
Common stock, $1.00 par value, authorized 100,000 shares;
issued 34,525 and 33,543 shares, respectively
 34,525 33,543 
Capital surplus 172,681 164,651 
Retained earnings 146,776 143,272 
Treasury stock, 2,280 and 1,692 shares at cost, respectively (36,030) (26,798)
Unearned restricted stock awards (1,376) (514)
Accumulated other comprehensive income (loss)—     
 Cumulative translation adjustments (1,647) (3,244)
 Minimum pension liability (13,245) (15,922)
 
 
 
 301,684 294,988 
 
 
 
 $709,292 $686,621 
 
 
 

The accompanying notes to consolidated financial statements
are an integral part of these statements.

29





AAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS'STOCKHOLDERS’ EQUITY
FOR THE THREE YEARS ENDED MAY 31, 20042007

 
 Common Stock
 Treasury Stock
  
  
 Unearned
Restricted
Stock
Awards

 Accumulated
Other
Comprehensive
Income (Loss)

  
 
 
 Capital
Surplus

 Retained
Earnings

 Comprehensive
Income (Loss)

 
 
 Shares
 Amount
 Shares
 Amount
 
 
 (In thousands)

 
Balance, May 31, 2001 29,371 $29,371 2,434 $(39,041)$148,316 $219,848 $(2,499)$(15,783)   
 Net income          (58,939)    $(58,939)
 Cash dividends          (4,430)      
 Issuance of common stock 4,147  4,147 (863) 13,783  16,404         
 Treasury stock    127  (1,728)          
 Exercise of stock options and stock awards 50  50     468         
 Restricted stock activity            1,361     
 Adjustment for net translation gain (loss)              2,507  2,507 
 Minimum pension liability, net of tax              (3,600)(3,600
)
 Comprehensive income for fiscal 2002                       $(60,032)
  
 
 
 
 
 
 
 
 
 
Balance, May 31, 2002 33,568 $33,568 1,698 $(26,986)$165,188 $156,479 $(1,138)$(16,876)   
 Net income          (12,410)    $(12,410)
 Cash dividends          (797)      
 Treasury stock    (6) 188           
 Exercise of stock options and stock awards (25) (25)    (537)        
 Restricted stock activity            624     
 Adjustment for net translation gain (loss)              6,980  6,980 
 Minimum pension liability, net of tax              (9,270)(9,270
)
 Comprehensive income for fiscal 2003                       $(14,700)
  
 
 
 
 
 
 
 
 
 
Balance, May 31, 2003 33,543 $33,543 1,692 $(26,798)$164,651 $143,272 $(514)$(19,166)   
 Net income          3,504     $3,504 
 Cash dividends                 
 Treasury stock    588  (9,232)          
 Exercise of stock options and stock awards 982  982     8,030         
 Restricted stock activity            (862)    
 Adjustment for net translation gain (loss)              1,597  1,597 
 Minimum pension liability, net of tax              2,677 2,677
 
 Comprehensive income for fiscal 2004                       $7,778 
  
 
 
 
 
 
 
 
 
 
Balance, May 31, 2004 34,525 $34,525 2,280 $(36,030)$172,681 $146,776 $(1,376)$(14,892)   
  
 
 
 
 
 
 
 
    

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unearned

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted

 

Other

 

 

 

 

 

Common Stock

 

Treasury Stock

 

Capital

 

Retained

 

Stock

 

Comprehensive

 

Comprehensive

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Surplus

 

Earnings

 

Awards

 

Income (Loss)

 

Income

 

 

 

(In thousands)

 

Balance, May 31, 2004

 

34,525

 

$

34,525

 

 

2,280

 

 

$

(36,030

)

$

172,681

 

$

146,776

 

 

$

(1,376

)

 

 

$

(14,892

)

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

15,453

 

 

 

 

 

 

 

 

$

15,453

 

 

Exercise of stock options and stock awards

 

1,328

 

1,328

 

 

987

 

 

(14,467

)

16,936

 

 

 

 

 

 

 

 

 

 

 

Restricted stock activity

 

 

 

 

 

 

 

 

 

 

(1,303

)

 

 

 

 

 

 

 

Adjustment for net translation loss

 

 

 

 

 

 

 

 

 

 

 

 

 

(150

)

 

 

(150

)

 

Minimum pension liability, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

(4,737

)

 

 

(4,737

)

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

10,566

 

 

Balance, May 31, 2005

 

35,853

 

$

35,853

 

 

3,267

 

 

$

(50,497

)

$

189,617

 

$

162,229

 

 

$

(2,679

)

 

 

$

(19,779

)

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

35,163

 

 

 

 

 

 

 

 

$

35,163

 

 

Exercise of stock options and stock awards

 

2,212

 

2,212

 

 

868

 

 

(19,167

)

37,876

 

 

 

 

 

 

 

 

 

 

 

Restricted stock activity

 

 

 

 

 

 

 

 

 

 

(3,490

)

 

 

 

 

 

 

 

Common stock issued in debt for equity transaction

 

2,724

 

2,724

 

 

 

 

 

46,718

 

 

 

 

 

 

 

 

 

 

 

Adjustment for net translation gain

 

 

 

 

 

 

 

 

 

 

 

 

 

1,058

 

 

 

1,058

 

 

Minimum pension liability, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

4,879

 

 

 

4,879

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

41,100

 

 

Balance, May 31, 2006

 

40,789

 

$

40,789

 

 

4,135

 

 

$

(69,664

)

$

274,211

 

$

197,392

 

 

$

(6,169

)

 

 

$

(13,842

)

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

58,660

 

 

 

 

 

 

 

 

$

58,660

 

 

Exercise of stock options and stock awards

 

1,441

 

1,441

 

 

366

 

 

(10,149

)

14,230

 

 

 

 

 

 

 

 

 

 

 

Tax benefit related to share- based plans

 

 

 

 

 

 

 

4,345

 

 

 

 

 

 

 

 

 

 

 

Restricted stock activity

 

 

 

 

 

 

 

(3,113

)

 

 

6,169

 

 

 

 

 

 

 

 

Adjustment for net translation gain

 

 

 

 

 

 

 

 

 

 

 

 

 

1,559

 

 

 

1,559

 

 

Minimum pension liability, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

1,921

 

 

 

1,921

 

 

Adoption of SFAS No. 158, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

(3,537

)

 

 

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

62,140

 

 

Balance, May 31, 2007

 

42,230

 

$

42,230

 

 

4,501

 

 

$

(79,813

)

$

289,673

 

$

256,052

 

 

$

 

 

 

$

(13,899

)

 

 

 

 

 


The accompanying notes to consolidated financial statements
are an integral part of these statements.statements

30





AAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

 
 For the Year Ended May 31,
 
 
 2004
 2003
 2002
 
 
 (In thousands)

 
Cash flows from operating activities:          
 Net income (loss) $3,504 $(12,410)$(58,939)
 Adjustments to reconcile net income (loss) to net cash provided from (used in) operating activities:          
   Depreciation and amortization  26,680  27,172  22,496 
   Deferred taxes  (5,116) (3,376) (2,394)
   Impairment and other special charges, net of tax    3,484  51,686 
   Changes in certain assets and liabilities, excluding effects of acquired businesses:          
    Accounts receivable  (41,374) 16,517  24,363 
    Inventories  15,602  17,755  (31,749)
    Equipment on or available for short-term lease  (3,233) 5,232  12,229 
    Equipment on long-term lease  (218) (1,796) (30,025)
    Accounts and trade notes payable  6,642  (2,841) (25,261)
    Accrued liabilities and taxes on income  13,143  (14,423) 5,861 
    Other, primarily prepaids  (1,058) (581) (2,171)
  
 
 
 
  Net cash provided from (used in) operating activities  14,572  34,733  (33,904)
  
 
 
 
Cash flows from investing activities:          
 Property, plant and equipment expenditures  (10,286) (9,930) (12,112)
 Proceeds from disposal of assets  92  113  589 
 Business acquisition      (13,251)
 Proceeds from sale of business and facility  16,922  2,969  2,229 
 Investment in leveraged leases  245  1,694  (373)
 Other  (1,347) (815) (986)
  
 
 
 
  Net cash provided from (used in) investing activities  5,626  (5,969) (23,904)
  
 
 
 
Cash flows from financing activities:          
 Proceeds from borrowings  89,701  24,000  115,504 
 Reduction in borrowings  (94,615) (56,643) (65,411)
 Financing costs  (3,459) (715) (484)
 Proceeds from stock offering      34,334 
 Cash dividends    (797) (4,430)
 Purchases of treasury stock      (205)
 Other    90  (897)
  
 
 
 
  Net cash provided from (used in) financing activities  (8,373) (34,065) 78,411 
  
 
 
 
Effect of exchange rate changes on cash  31  (67) 110 
  
 
 
 
Increase (decrease) in cash and cash equivalents  11,856  (5,368) 20,713 
Cash and cash equivalents, beginning of year  29,154  34,522  13,809 
  
 
 
 
Cash and cash equivalents, end of year $41,010 $29,154 $34,522 
  
 
 
 

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

 

 

(In thousands)

 

Cash flows provided from (used in) operating activities:

 

 

 

 

 

 

 

Net income

 

$

58,660

 

$

35,163

 

$

15,453

 

Adjustments to reconcile net income to net cash provided from (used in) operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

32,199

 

29,222

 

29,178

 

Deferred tax provision - continuing operations

 

20,411

 

8,433

 

2,112

 

Excess tax benefits from exercise of stock options

 

(4,345

)

 

 

Gain on sale of product line

 

(5,358

)

 

 

Impairment charges

 

7,652

 

 

 

Loss (gain) on extinguishment of debt

 

(2,927

)

3,893

 

3,562

 

Earnings from aircraft joint ventures

 

(10,952

)

 

 

Gain on sale of investment

 

(915

)

 

 

Loss on disposal of business, net of tax

 

 

 

2,321

 

Changes in certain assets and liabilities:

 

 

 

 

 

 

 

Accounts and trade notes receivable.

 

(25,160

)

(9,324

)

(17,596

)

Inventories

 

(8,567

)

(58,297

)

(12,013

)

Equipment on or available for short-term lease

 

(5,259

)

(12,892

)

(3,154

)

Equipment on long-term lease

 

(62,491

)

(76,156

)

18,728

 

Accounts payable.

 

6,473

 

19,735

 

19,244

 

Accrued liabilities and taxes on income

 

1,903

 

12,282

 

5,907

 

Other liabilities.

 

(4,696

)

10,493

 

 

Other.

 

(17,867

)

(3,034

)

(12,804

)

Net cash provided from (used in) operating activities.

 

(21,239

)

(40,482

)

50,938

 

Cash flows used in investing activities:

 

 

 

 

 

 

 

Property, plant and equipment expenditures

 

(29,891

)

(16,296

)

(13,033

)

Proceeds from disposal of assets

 

51

 

205

 

7

 

Proceeds from sale of product line

 

6,567

 

 

 

Proceeds from disposal of business

 

 

 

7,700

 

Proceeds from sale of available for sale securities

 

11,612

 

 

 

Investment in available for sale securities.

 

(10,697

)

 

 

Companies acquired

 

(38,478

)

 

 

Proceeds from aircraft joint ventures

 

32,108

 

6,439

 

 

Investment in aircraft joint ventures

 

(9,556

)

(23,245

)

(11,223

)

Investment in leveraged leases.

 

139

 

183

 

122

 

Other

 

(984

)

89

 

(1,157

)

Net cash used in investing activities

 

(39,129

)

(32,625

)

(17,584

)

Cash flows provided from (used in) financing activities:

 

 

 

 

 

 

 

Proceeds from borrowings

 

30,355

 

161,000

 

 

Reduction in borrowings.

 

(20,439

)

(20,376

)

(24,005

)

Financing costs

 

(864

)

(5,371

)

(34

)

Excess tax benefits from exercise of stock options

 

4,345

 

 

 

Other, primarily stock option exercises

 

8,576

 

9,402

 

2

 

Net cash provided from (used in) financing activities

 

21,973

 

144,655

 

(24,037

)

Effect of exchange rate changes on cash

 

(26

)

(148

)

11

 

Increase (decrease) in cash and cash equivalents.

 

(38,421

)

71,400

 

9,328

 

Cash and cash equivalents, beginning of year

 

121,738

 

50,338

 

41,010

 

Cash and cash equivalents, end of year

 

$

83,317

 

$

121,738

 

$

50,338

 

The accompanying notes to consolidated financial statements
are an integral part of these statements.

31






AAR CORP. AND SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Dollars in thousands, except per share amounts)

1.   Summary of Significant Accounting Policies

Description of Business

AAR CORP. suppliesis a varietydiversified provider of products and services to the worldwide aviation/aerospace industry. We also marketaviation and sell certain of our products to the U.S. and foreign governments.defense industries. Products and services are sold primarily to domesticinclude: aviation supply chain and foreignparts support programs; maintenance, repair and overhaul of aircraft and landing gear; design and manufacture of specialized mobility and cargo systems and composite structures; and aircraft sales and leasing. We serve commercial airlines, businessand governmental aircraft fleet operators, aviation original equipment manufacturers aircraft leasing companies, domestic and foreign military agencies and independent aviation support companies.service providers around the world.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of intercompany accounts and transactions. The equity method of accounting is used for investments in other companies in which we have significant influence; generally this represents common stock ownership of at least 20% and not more than 50% (see Note 7 for a discussion of aircraft joint ventures).

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. Service revenuesSales of certain defense products are recognized upon customer acceptance, which includes transfer of title and transfer of risk of loss. 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, the serviced units are typically shipped to the customer immediately upon completion of the related services. Sales and related cost of sales for certain long-term manufacturing contracts and for certain large airframe maintenance contracts are recognized by the percentage of completion method, either based on the relationship of costs incurred to date to estimated total costs underor the respective contracts.units of delivery method. 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.

GoodwillCertain supply chain management programs we provide 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.

Goodwill

Under Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill“Goodwill and Other Intangible Assets"Assets”, goodwill and other intangible assets deemed to have indefinite lives are no longernot amortized, but are subject to annual impairment tests. We adopted the provisions


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

1.   Summary of SFAS No. 142 in the first quarter of fiscal 2002, and as a result did not record any goodwill amortization for the fiscal years ended May 31, 2004, 2003 and 2002.Significant Accounting Policies (Continued)

The amount reported under the caption on the May 31, 2004“Goodwill and 2003 consolidated balance sheets "Goodwill, net"other intangible assets, net” is comprised entirely of goodwill and intangible assets associated with acquisitions we made, principally since the beginning of fiscal 1998. Each of the acquisitions involved a single business that now comprises or is included in a single operating segment. We were not required to allocate goodwill related to specific acquisitions across two or more segments. Upon adoption of SFAS No. 142, and forFor the fiscal 2004 annual goodwill impairment test, we comparedcompare an estimate forof the fair value of each of our reportable segments to its



carrying amount. The estimated fair value of each reportable segment was determined utilizing a valuation technique based on a multiple of earnings.

Goodwill by reportable segment is as follows:

 
 May 31,
 
 2004
 2003
Inventory and Logistic Services $12,444 $13,649
Maintenance, Repair and Overhaul  13,764  14,050
Manufacturing  18,213  18,252
Aircraft and Engine Sales and Leasing    
  
 
  $44,421 $45,951
  
 

 

 

May 31,

 

 

 

2007

 

2006

 

Aviation Supply Chain

 

$

20,136

 

$

20,110

 

Maintenance, Repair and Overhaul

 

14,940

 

5,838

 

Structures and Systems

 

37,611

 

18,484

 

 

 

$

72,687

 

$

44,432

 

 During

The increase in goodwill during fiscal year 2004, we reduced goodwill by $1,5832007 was attributable to reflect purchase accounting adjustments to establish deferred taxes primarily for accounts receivable and inventories, forthe acquisitions made in prior fiscal years.

Stock Options

        We have an employee stock option plan which is more fully describeddiscussed in Note 5. We account for this plan under11. At May 31, 2007, intangible assets, other than goodwill, are comprised of customer relationships of $1,000 and a covenant not to compete agreement of $580. The customer relationship is being amortized over a three year period and the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issuedcovenant not to Employees", and related interpretations. No stock-based employee compensation cost related to our stock option plancompete is reflected in net income, as each option granted under this plan had an exercise price equal to the market value of the underlying common stock on the date of grant.being amortized over a five year period.

        The following table illustrates the effect on net income (loss) and earnings (loss) per share if we had applied the fair value recognition provisions of SFAS No. 123 to our stock option plan.

 
 For the Year Ended May 31,
 
 
 2004
 2003
 2002
 
Net income (loss) as reported $3,504 $(12,410)$(58,939)
Add (deduct): Stock-based compensation expense (income) included in net income (loss) as reported, net of tax  323  142  (150)
Deduct: Total compensation expense determined under fair value method for all awards, net of tax  (2,188) (2,758) (2,810)
  
 
 
 
Pro forma net income (loss) $1,639 $(15,026)$(61,899)
  
 
 
 
Earnings (loss) per share-basic: As reported $0.11 $(0.39)$(2.08)
  Pro forma $0.05 $(0.47)$(2.19)
Earnings (loss) per share-diluted: As reported $0.11 $(0.39)$(2.08)
  Pro forma $0.05 $(0.47)$(2.19)

        The fair value weighted average per share of stock options granted during fiscal 2004, 2003 and 2002 was $4.93, $3.82 and $6.25, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

 
 Stock Options Granted In Fiscal Year
 
 
 2004
 2003
 2002
 
Risk-free interest rate 3.1%2.5%4.5%
Expected volatility of common stock 67.2%64.0%54.8%
Dividend yield 0.0%1.6%1.9%
Expected option term in years 4.0 4.0 4.0 

Cash and Cash Equivalents

        We consider all highly liquid investments with maturities of three months or less to be cash equivalents. At May 31, 20042007 and 20032006, cash equivalents of approximately $11,317$0 and $4,349,$40,535, respectively, representconsist of investments in funds holding high-quality commercial paper. The carrying amount of cash equivalents approximates fair value at May 31, 20042007 and 2003,2006, respectively. As

Marketable Securities

During the fourth quarter of May 31, 2004, $7,313fiscal 2007, we sold an investment in equity securities that was classified as available for sale. These securities were acquired in fiscal 2007, and had a cost basis of cash was restricted to support letters of credit.

Transfer of Financial Assets

        During fiscal 2001, we adopted SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", which requires us to recognize$10,697. Proceeds on the financial and servicing assets we controlsale were $11,612 and the liabilities we have incurred, and to derecognize financial assets when control has been surrendered.

        On March 21, 2003, we completed a $35,000 accounts receivable securitization program with LaSalle Business Credit L.L.C. (LaSalle). The termgain of the agreement$915 is one year, renewable annually and bears interest at LIBOR plus 300 basis points. Under the program, on each business day certain of our subsidiaries sell all new eligible receivables to an entity that is a wholly owned and consolidated subsidiary of the Company. This entity in turn sells an undivided percentage ownership interest in such eligible receivables to LaSalle. Certain classes of receivables are not intended for sale to the entity, including, but not limited to, accounts receivable that are not eligible receivables under the program at the time of sale, receivables related to sales to certain foreign entities and receivables generated by sales to governmental entities other than the U.S. government. Costs related to this arrangement are includedreported in interest expense.

        At May 31, 2004, accounts receivable sold under the program were $0. At May 31, 2003, accounts receivable sold under the program were $44,065income and the cash proceeds were $26,800. This resulted in a $26,800 reduction in accounts receivableother on the May 31, 2003 consolidated balance sheet. The retained undivided intereststatements of $17,265 as of May 31, 2003 is included in accounts receivable at fair value, which takes into consideration expected credit losses based on the specific identification of uncollectable accounts. Because substantially all accounts receivable sold carry 30-day payment terms, the retained interest at May 31, 2003 was not discounted.operations.



Foreign Currency

All balance sheet accounts of foreign subsidiaries transacting business in currencies other than the U.S. dollar are translated at year-end exchange rates. Revenues and expenses are translated at average exchange rates during the year. Translation adjustments are excluded from the results of operations and are recorded in stockholders'stockholders’ equity as a component of accumulated other comprehensive income (loss).loss.

Financial Instruments and Concentrations of Market or Credit Risk

Financial instruments that potentially subject us to concentrations of market or credit risk consist principally of trade receivables. While our trade receivables are diverse based on theand represent a number of entities and geographic regions, the majority are with the U.S. Government,Department of Defense and its agencies and contractors and entities in the aviation/aerospaceaviation industry. Accounts receivable due from the U.S. Department of Defense were


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

1.   Summary of Significant Accounting Policies (Continued)

$22,098 and $16,347 at May 31, 2007 and 2006, respectively. We perform regular evaluations of customer payment experience, current financial condition and risk analysis. We typicallymay require collateral in the form of security interests in assets, letters of credit, and/or obligation guarantees from financial institutions for transactions executed on other than on normal trade terms.

SFAS No. 107, "Disclosures“Disclosures about Fair Value of Financial Instruments"Instruments”, requires disclosure of the fair value of certain financial instruments. Cash and cash equivalents, accounts receivable, short-term borrowings and accounts payable are reflected in the consolidated financial statements at fair value because of the short-term maturity of these instruments. The carrying value of long-term debt bearing a variable interest rate approximates fair market value.

Fair value estimates are made at a specific point in time based on relevant market information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Inventories

Inventories are valued at the lower of cost or market. Cost is determined by the specific identification, average cost or first-in, first-out methods. We also purchase aircraft and engines for disassembly to individual parts and components. Costs are assigned to these individual parts and components based on list prices from original equipment manufacturers and recent sales history.

The following is a summary of inventories:


 May 31,

 

May 31,

 


 2004
 2003

 

2007

 

2006

 

Raw materials and parts $45,823 $45,702

 

$

55,702

 

$

58,421

 

Work-in-process 20,419 22,604

 

36,580

 

30,651

 

Purchased aircraft, parts, engines and components held for sale 140,657 151,588

 

152,379

 

156,618

 

 
 

 

$

244,661

 

$

245,690

 

 $206,899 $219,894
 
 

Government Grants

In connection with our occupancy of the Indianapolis Maintenance Center (IMC), the State of Indiana and the City of Indianapolis committed $7,000 of government grants to assist with the initial mobilization and start-up of the facility, as well as to assist us with the purchase of certain capital equipment. During fiscal 2007, 2006 and 2005, we received $0, $300 and $3,700, respectively, of grants for mobilization, training and other start-up related costs, and have offset the receipt of these grants against applicable mobilization and other start-up related costs incurred by us.

Equipment under Operating Leases

Lease revenue is recognized as earned. The cost of the asset under lease is original purchase price plus overhaul costs. Depreciation for aircraft is computed on a straight-line method over the estimated service life of the equipment. The balance sheet classification is generally based on the lease term, with fixed-term leases less than twelve months generally classified as short-term and all others generally classified as long-term.


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

1.   Summary of Significant Accounting Policies (Continued)

Equipment on short-term lease consists of aircraft engines and parts on or available for lease to satisfy customers'customers’ immediate short-term requirements. The leases are renewable with fixed terms, which generally vary from one to twelve months. Equipment on long-term lease consists of aircraft and engines on lease with commercial airlines for more than twelve months.months (see Note 8).

Our aircraft and engine portfolio recorded on our consolidated balance sheet includes 8seven narrow-body and 2two wide-body aircraft and several types of engines. Of the nine aircraft owned by us outside of aircraft joint ventures, five were acquired prior to September 11, 2001. Several engines certain of whichalso were acquired prior to September 11, 2001. Demand and lease rates for manycertain of these assets have not returned to pre-September 11, 2001 levels. In accordance with SFAS No. 144, we are required to test for impairment of these assets and previously adjusted the carrying value for certain of these assets (see Note 2)13). During the first quarter of fiscal 2007, we recorded an impairment charge of $2,902 on a wide-body aircraft originally purchased prior to September 11, 2001. The lease and non-recourse debt on the aircraft were restructured during the quarter, and we made the decision to offer the aircraft for sale and recorded the impairment charge to reduce the carrying value of the aircraft to estimated net realizable value. During the fourth quarter of fiscal 2005, we recorded a $900 charge related to the write-down of an aircraft as a result of a renegotiated lease with an airline customer operating under bankruptcy protection. When applying the provisions of SFAS No. 144 to our aircraft and engine portfolio, we have utilized certain assumptions when estimatingto estimate future undiscounted cash flows, including current and future lease rates, lease terms, residual values and market conditions and trends impacting future demand. Unfavorable differences between actual results and expected results could result in future impairments in our aircraft and engine lease portfolio.

        EachAll of the aircraft in our aircraft portfolio are currently on lease and we expect to re-lease these aircraft as the current lease expires.lease. Future rent due to us under non-cancelable leases for aircraft and engines during each of the next fourfive fiscal years is $12,182$29,025 in 2005, $7,3292008, $26,492 in 2006, $1,6932009, $23,357 in 20072010, $17,059 in 2011 and $358$16,948 in 2008.2012.

Property, Plant and Equipment

Depreciation is computed on the straight-line method over useful lives of 10-40 years for buildings and improvements and 3-10 years for equipment, furniture and fixtures and capitalized software. Leasehold improvements are amortized over the shorter of the estimated useful life or the term of the applicable lease.

Repair and maintenance expenditures are expensed as incurred. Upon sale or disposal, cost and accumulated depreciation are removed from the accounts, and related gains and losses are included in results of operations.

Leveraged LeasesLease

We are an equity participant in a leveraged lease transactions.transaction. The equipment cost in excess of equity contribution is financed by a third partiesparty in the form of secured debt. Under the lease agreements,agreement, the third parties haveparty has no recourse against us for nonpayment of the obligations.obligation. The third-party debt is collateralized by the lessees'lessees’ rental obligationsobligation and the leased equipment.

We have ownership rights to the leased assetsasset and are entitled to the tax deductionsdeduction for depreciation on the leased assetsasset and for interest on the secured debt financing.


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

1.   Summary of Significant Accounting Policies (Continued)

Income taxes

Income taxes are determined in accordance with SFAS No. 109, "Accounting“Accounting for Income Taxes"Taxes”.

Statements ofSupplemental Information on Cash Flows

Supplemental information on cash flows follows:


 For the Year Ended May 31,

 

For the Year Ended May 31,

 


 2004
 2003
 2002

 

2007

 

2006

 

2005

 

Interest paid $15,246 $17,604 $16,817

 

$

13,650

 

$

13,588

 

$

13,764

 

Income taxes paid 740 3,460 1,960

 

1,948

 

1,303

 

591

 

Income tax refunds and interest received 1,026 865 4,075

 

1,221

 

1,137

 

1,138

 


Noncash operating and financing activities:

 

 

 

 

 

 

Assets acquired with assumption of notes payable

 

$


 

$

36,025

 

$

29,737

 

During fiscal 2003,2007, we purchasedcapitalized $977 of interest primarily related to capital projects in our Structures and Systems segment.

During the third quarter of fiscal 2006, we acquired $50,645 aggregate principal amount of our 2.875% Convertible Senior Notes due 2024, or approximately 76% of the previously outstanding principal amount, in exchange for nominal consideration our partner's 50% equityan aggregate 2,724 newly issued shares of common stock plus $3,893 in cash, in privately negotiated transactions exempt from the registration requirements under the Securities Act of 1933, as amended. The number of shares issued was equivalent to the number into which the notes were convertible under the original terms of the notes. We recorded a $3,893 pre-tax loss on the exchange of the notes into stock in advance of the call date of the notes; this loss was comprised of interest in a joint venture that owned a wide-body aircraft subjectthe note holders would otherwise have been entitled to non-recourse debt.receive as well as an incentive payment for the exchange. As a result of these transactions, our long-term debt decreased by $50,645 and stockholders’ equity increased by $46,600. The 2,724 newly issued shares did not impact diluted earnings per share because the consolidationequivalent shares were already included in the diluted earnings per share calculation.

As of May 31, 2007, the outstanding balance of the joint venture,2.875% Convertible Senior Notes due 2024 was $16,355 and as of March 15, 2006, these notes can be converted into shares of common stock at the aircraft owned by the joint venture was recorded in our accounts for $36,025, which represented an amount equal to the historical cost of our investment in the joint venture, plus the nominal consideration paid to the other party, plus the amountoption of the non-recourse debt that was associated withnote holder.

During fiscal 2007, 2006 and 2005, treasury stock increased $10,149, $19,167 and $14,467, respectively, principally reflecting the aircraft. See Note 8 for information concerningimpact from the assumptionexercise of notes payable in fiscal 2002.stock options.

Use of Estimates

We have made estimates and utilized certain assumptions relating to the reporting of assets and liabilities and the disclosures of contingent liabilities to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States. Actual results could differ from those estimates.

New Accounting Standards

In March 2004,September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 provides guidance regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether financial statement restatement is


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

1.   Summary of Significant Accounting Policies (Continued)

necessary. SAB 108 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. The adoption of SAB 108 did not have a material impact on our results of operations or financial position.

In July 2006, the Financial Accounting Standards Board ("FASB")(FASB) issued Interpretation No. 48 (FIN No. 48), “Accounting for Uncertainty in Income Taxes—an exposure draft of Proposed Statement of Financial Accounting Standards, Share-Based Payment, an amendmentinterpretation of FASB Statement No. 123. This proposed Statement addresses109.” FIN No. 48 clarifies the accountingrecognition threshold and measurement requirements for transactions in which an enterprise exchanges its equity instruments for employee services. It also addresses transactions in which an enterprise incurs liabilities that are based on the fair value of the enterprise's equity instrumentstax positions taken or that may be settled by the issuance of those equity instruments in exchange for employee services. For public entities, the cost of employee services received in exchange for equity instruments, including employee stock options, would be measured based on the grant-date fair value of those instruments. That cost would be recognized as compensation expense over the service period, which would normally be the vesting period.


        If the proposed statement were adopted by us as currently proposed, it would require that compensation expense be recorded for employee stock options vesting or granted subsequent to May 31, 2005. The ultimate impact on diluted earnings per share of expensing stock options will be dependent upon the final pronouncement issued by the FASB, the methodexpected to be used for valuation of stock options determined by ustaken in tax returns and the amount of future stock option grants.

        Also in March 2004, the FASB issued Proposed FASB Staff Position No. FAS 106-b ("FSP"), "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003." The FSP provides guidance on the accountingrelated classification and disclosure. The provisions of FIN No. 48 are effective for fiscal years beginning after December 15, 2006. Accordingly, we will adopt FIN No. 48 no later than the effectsbeginning of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 for employers that sponsor post-retirement health care plans that provide prescription drug benefits. The FSPfiscal year 2008. FIN No. 48 will not have a material effectimpact on us because we offer prescription drug benefits to approximately 40 retirees at May 31, 2004.our results from operations or financial position.

ReclassificationIn September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS No. 157 establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We have not yet determined the impact of the adoption of this new accounting standard.

Reclassification

Certain amounts in the prior years'years’ consolidated financial statements have been reclassified to conform to the current year'syear’s presentation.

2.    Impairment and Special Charges

        The components of the fiscal 2003 and fiscal 2002 impairment charges were as follows:

 
 For the Year Ended May 31,
 
 2003
 2002
Engine and airframe parts $2,360 $56,000
Whole engines  3,000  11,400
Loss accruals for engine operating leases    8,500
  
 
  $5,360 $75,900
  
 

        Prior to September 11, 2001 we were executing our plan to reduce our investment in support of older generation aircraft in line with the commercial airlines' scheduled retirement plans for these aircraft. The events of September 11 caused a severe and sudden disruption in the commercial airline industry, which brought about a rapid acceleration of those retirement plans. System-wide capacity was reduced by approximately 20%, and many airlines cancelled or deferred new aircraft deliveries. Based on management's assessment of these and other conditions, in the second quarter ended November 30, 2001, we reduced the value and provided loss accruals for certain of our inventories and engine leases which support older generation aircraft by $75,900, of which $57,900 was related to the Inventory and Logistic Services segment and $18,000 was related to the Aircraft and Engine Sales and Leasing segment.

        The fiscal 2002 writedown for the engine and airframe parts was determined by comparing the carrying value for inventory parts that support older generation aircraft to their net realizable value. In determining net realizable value, we assigned estimated sales prices taking into consideration historical selling prices and demand, as well as anticipated demand. The $11,400 writedown during fiscal 2002 for whole engines related to assets that are reported in the caption "Equipment on or available for short-term lease" and was determined by comparing the carrying value for each engine to an estimate of its undiscounted future cash flows. In those instances where there was a shortfall, the impairment was



measured by comparing the carrying value to an estimate of the asset's fair market value. The loss accruals for engine operating leases were determined by comparing the scheduled purchase option prices to the estimated fair value of such equipment. In those instances where the scheduled purchase option price exceeded the estimated fair value, an accrual for the estimated loss was recorded (see Note 8).

        During the fourth quarter of fiscal 2003, we recorded additional impairment charges related to certain engine and airframe parts and whole engines in the amount of $5,360. The fiscal 2003 impairment charge was based upon an updated assessment of the net realizable values for certain engine and airframe parts and future undiscounted cash flows for whole engines. Of the $5,360 impairment charge recorded during fiscal 2003, $2,360 related to the Inventory and Logistic Services segment and $3,000 related to the Aircraft and Engine Sales and Leasing segment.

        A summary of the carrying value of impaired inventory and engines, after giving effect to the impairment charges recorded by us during fiscal 2003 and fiscal 2002 are as follows:

 
 May 31,
2004

 May 31,
2003

 May 31,
2002

 November 30,
2001

Net impaired inventory and engines $51,500 $56,240 $75,600 $89,600

        Proceeds from sales of impaired inventory and engines for the twelve-month periods ended May 31, 2004 and 2003 were $7,300 and $12,100, respectively, and $15,600 for the six-month period ended May 31, 2002.

        In addition, we recorded special charges of $10,100 during the three-month period ended November 30, 2001. Of the $10,100 special charge, $5,700 related to an increase in the allowance for doubtful accounts to reflect the inability to recover certain receivables. The $5,700 charge to increase the allowance for doubtful accounts principally related to our assessment of prior estimates of recoveries from certain bankrupt airlines. We increased the allowance to give effect to the decline in values of aviation equipment that had been expected to be recovered from the bankrupt airlines. The increase in the allowance was classified as a special charge because the decline in values of the assets was attributable to the events of September 11, 2001.

        The remaining balance of the special charge related to a $1,500 severance accrual and a $2,900 other asset impairment charge. During the second quarter ended November 30, 2001 and in connection with overall cost savings initiatives, we reduced our work force by approximately 150 employees. Affected employees included management and salaried employees, salespersons and hourly employees at certain of our facilities. The $2,900 other asset impairment charge relates to an investment in marketable securities, which was written down to fair market value. In February 2002, we liquidated our position in this investment; proceeds received approximated net book value after taking into consideration the impairment charge.


3.   Financing Arrangements

Revolving Credit Facility

    Short-Term Borrowings

        Our short-term borrowings at MayOn August 31, 2004 and 2003 were as follows:

 
 May 31,
 
 2004
 2003
Short-term debt $1,896 $24,000
Current maturities of long-term debt  760  35,729
Current maturities of non-recourse debt  736  32,527
  
 
  $3,392 $92,256
  
 

        During the fourth quarter of fiscal 2003,2006, we entered into a secured$140,000 unsecured revolving credit facility with Merrill Lynch Capital, a DivisionLaSalle Bank National Association and various other lenders. Under certain circumstances, we may request an increase to the revolving commitment in an aggregate amount of Merrill Lynch Business Financial Services, Inc. Thisup to $35,000, not to exceed $175,000 in total. The credit facility replaced, in part, previous unsecured credit arrangements with three domestic banks which expired during the fourth quarter of fiscal 2003. The maximum amount available to usexpires on August 31, 2010 and borrowings under this agreement is $30,000 and as of May 31, 2004 and 2003, the amount available was $22,449 and $24,800, respectively. This availability is based on a formula of qualifying assets and is secured by substantially all of our inventories and certain other assets. The term of the facility is three years, bearsbear interest at LIBOR plus 300125 to 200 basis points and carriesbased on certain financial measurements. The credit facility also includes a one-percent facilitynon-use fee which is currently equal to 30 basis points on the unused portion of the agreement. The amountfacility.

There were no borrowings outstanding under either this agreement was $0 and $24,000 at May 31, 2004 and 2003, respectively.

facility or our previous revolving credit facilities during fiscal 2007. Short-term borrowing activity under our revolving credit facilities during fiscal 2006 and 2005 was as follows:


 For the Year Ended May 31,
 

 

For the Year Ended May 31,

 


 2004
 2003
 2002
 

 

2006

 

2005

 

Maximum amount borrowed $24,008 $41,700 $80,000 

 

$

25,000

 

$

21,000

 

Average daily borrowings 7,878 32,661 36,152 

 

7,216

 

5,248

 

Average interest rate during the year 3.98% 3.4% 2.98%

 

6.76

%

5.47

%

 

37




AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

2.   Financing Arrangements (Continued)

In conjunction with entering into the new credit facility, we terminated our secured revolving credit agreement with Merrill Lynch Capital during the first quarter of fiscal 2007, and our accounts receivable securitization program during the second quarter of fiscal 2007. No borrowings were outstanding and no accounts receivable were sold at the date of termination. No material penalties or fees resulted from the termination of these arrangements.

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


 May 31,
 

 

May 31,

 


 2004
 2003
 

 

2007

 

2006

 

Recourse debt:     
Notes payable due October 15, 2003 with interest at 7.25% payable semi-annually on April 15 and October 15 $ $22,600 
Notes payable with interest at 8.0%, due in equal installments on October 15, 2004, 2005 and 2006  16,900 
Notes payable due June 29, 2005 with interest at 4.6% payable monthly  21,291 

Recourse debt

 

 

 

 

 

Notes payable due December 15, 2007 with interest at 6.875% payable semi-annually on June 15 and December 15 54,370 60,000 

 

$

31,166

 

$

40,200

 

Notes payable due May 15, 2008 with interest at 7.98% payable semi-annually on June 1 and December 1 20,000 20,000 

 

20,000

 

20,000

 

Mortgage due July 1, 2008 with interest at 6.25% 10,627  
Notes payable due May 15, 2011 with interest at 8.39% payable semi-annually on June 1 and December 1 55,000 55,000 

 

55,000

 

55,000

 

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 February 1, 2024 with interest at 2.875% payable semi-annually on February 1 and August 1 75,000  

 

16,355

 

16,355

 

Other, primarily industrial revenue bonds, (secured by trust indentures on property, plant and equipment) with weighted average interest of approximately 1.25% to 6.65% at May 31, 2004 3,197 4,596 
 
 
 

Convertible notes payable due February 1, 2026 with interest at 1.75% payable semi-annually on February 1 and August 1

 

150,000

 

150,000

 

Industrial revenue bond, (secured by trust indenture on property, plant and equipment) due December 1, 2010 with floating interest rate, payable quarterly—interest 3.93% at May 31, 2007

 

708

 

908

 

Total recourse debt 218,194 200,387 

 

284,229

 

293,463

 

Current maturities of recourse debt (760) (35,729)

 

(51,366

)

(200

)

 
 
 
Long-term recourse debt $217,434 $164,658 

 

$

232,863

 

$

293,263

 

 
 
 
Non-recourse debt:     
Non-recourse note payable due July 2005 with interest at 5.25% $31,968 $32,527 

Non-recourse debt

 

 

 

 

 

Non-recourse note payable due December 1, 2007 with interest at 6.00%

 

$

22,252

 

$

27,241

 

Non-recourse note payable due September 23, 2007 with interest at 8.11%

 

15,000

 

 

Non-recourse note payable due April 3, 2015 with interest at 8.38%

 

6,375

 

 

Total non-recourse debt

 

43,627

 

27,241

 

Current maturities of non-recourse debt (736) (32,527)

 

(22,879

)

(1,928

)

 
 
 
Long-term non-recourse debt $31,232 $ 

 

$

20,748

 

$

25,313

 

 
 
 

 On July 1, 2003,

During fiscal 2007 and 2006, we completed an $11,000 financing secured byretired $9,034 and $7,180, respectively, of 6.875% notes payable due in December 2007. During the first quarter of fiscal 2007, we restructured the lease and non-recourse debt associated with a mortgage on our Wood Dale, Illinois facility. The term767-300 aircraft. As part of the financing is five years utilizingrestructuring, the lender of the non-recourse debt reduced the outstanding principal balance by $2,927 which resulted in a fifteen-year amortization with a LIBOR-based interest rategain on extinguishment of no less than 6.25%. At May 31, 2004, the net book value of our Wood Dale, Illinois facility is $15,580.same amount (see Note 13).


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

2.   Financing Arrangements (Continued)

On February 3, 20041, 2006, we completed the sale of $75,000$150,000 principal amount of convertible senior notes. The notes are due on February 1, 20242026 unless earlier redeemed, repurchased or converted, and bear interest at 2.875%1.75% payable semiannually on February 1 and August 1. Costs associated with this transaction of approximately $4,875 are being amortized over a seven-year period. Net proceeds from this transaction were $145,125 and were used in part to repurchase $25,000 of accounts receivable which had been sold under our accounts receivable securitization facility, to repay $25,000 outstanding under our secured revolving credit facility and to purchase aviation equipment for $11,232 which was subject to an operating lease.

        TheA holder may convert the notes are convertible into shares of AAR common stock based on a conversion rate of 53.792433.9789 shares per $1,000 principal amount of notes, which is equivalent to an initial conversion price of approximately $18.59$29.43 per share, under the following circumstances: (i) onduring any businesscalendar quarter beginning after March 31, 2006 (and only during such calendar quarter), if, as of the last day up toof the maturity date, ifpreceding calendar quarter, the closing sale price of our common stock for at least 20 trading days in thea period of 30 consecutive trading day perioddays ending on the eleventhlast trading day of any fiscalsuch preceding calendar quarter is greatermore than



120% of the applicable conversion price on the eleventh trading dayper share of that quarter; (ii) at any time after February 1, 2019, if the closing price of AAR common stock on any tradingthe last day after February 1, 2019, is greater than 120% of the then applicable conversion price; (iii) at any time until February 1, 2019,such preceding calendar quarter; (ii) during the five business day period after any five consecutive businesstrading day period in which the trading price for a note“trading price” per $1,000 principal amount of notes for each day of that trading period was less than 98% of the product of the closing sale price of our common stock on such correspondingand the then applicable conversion rate; (iii) upon a redemption notice; (iv) if a designated event or similar change of control transaction occurs; (v) upon specified corporate transactions; or (vi) during the ten trading day period ending at the close of business on the business day immediately preceding the stated maturity date on the notes. Upon conversion, we will have the right to deliver, in lieu of shares of our common stock, cash or a combination of cash and shares of common stock, at our option, in an amount per note equal to the applicable conversion rate multiplied by the application conversion rate; (iv) we call the notes for redemption; (v) during any period in which the credit rating assigned to our long-term senior debt by Moody's Investor Services is below Caa1 and by Standard & Poor's Rating Services is below B, the credit rating assigned to our long-term senior debt is suspended or withdrawn by both such rating agencies, or neither rating agency is rating our long-term senior debt; or (vi) specified corporate transactions occur.applicable stock price.

We may redeem for cash all or a portion of the notes at any time on or after February 1, 20086, 2013 at specified redemption prices. Holders of the notes have the right to require us to repurchase inpurchase for cash all or any portion of the notes on February 1, 2010, 20142013, 2016 and 2019. In each case, the repurchase2021 at a price payable will be equal to 100% of the principal amount of the notes to be repurchased, plus accrued interest and unpaid interest, and liquidated damages, if any, to but not including, the date of repurchase.

purchase date. The notes are senior, unsecured obligations and rank equal in right of payment with all other unsecured and unsubordinated indebtedness. Costs associated

On May 23, 2007, we financed a narrow-body aircraft purchase with a $15,000 note payable. The note matures September 23, 2007 and bears interest at LIBOR plus 275 basis points. On July 19, 2007, we refinanced this transactionnote payable. Proceeds of the new loan were $2,585$17,000 and are being amortized over a six-year period.the term of the financing is five years with interest at 7.22%. Accordingly, we have classified the $15,000 note payable outstanding at May 31, 2007 as long-term on the consolidated balance sheet.

        Net proceeds from this transaction were $72,415 and were used in part to repurchase $35,000The mortgage loan due August 1, 2015 is secured by our Wood Dale, Illinois facility. At May 31, 2007, the net book value of accounts receivable which had been sold under our accounts receivable securitizationWood Dale, Illinois facility to repay $16,900 of 8.0% notes prior to their maturity, to repay $4,000 outstanding under our revolving credit facility, to retire $13,426 of notesis $14,593. The non-recourse note payable due in June 2005 and to retire $3,500December 2007 is secured by a wide-body aircraft. At May 31, 2007, the net book value of notes payable due in December 2007.this aircraft is $26,430.

We are subject to a number of covenants under our financing arrangements, including restrictions which relate to the payment of cash dividends, maintenance of minimum net working capital and tangible


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

2.   Financing Arrangements (Continued)

net worth levels, fixed charge coverage ratio, sales of assets, additional financing, purchase of our shares and other matters. We are currently prohibited from paying dividends or purchasing our shares pursuant to the most restrictive financial covenant concerning consolidated retained earnings. We are in compliance with all financial covenants under our financing arrangements. The aggregate amount of long-term recourse debt maturing during each of the next five fiscal years is $760 in 2005, $792 in 2006, $831 in 2007, $75,241$51,366 in 2008, $200 in 2009, $200 in 2010, $55,108 in 2011 and $8,820$0 in 2009.2012. Our long-term recourse debt was estimated to have a fair value of approximately $208,200$300,000 at May 31, 2004.2007. The fair value was determined using available market information.



4.    Income Taxes3.   Stock-Based Compensation

        The provision for income taxes includes the following components:

 
 For the Year Ended May 31,
 
 
 2004
 2003
 2002
 
Current:          
 Federal $1,329 $293 $(2,832)
 State  270  270  250 
  
 
 
 
   1,599  563  (2,582)
Deferred  (3,396) (7,643) (36,708)
  
 
 
 
  $(1,797)$(7,080)$(39,290)
  
 
 
 

        The deferred tax provision (benefit) results primarily from differences between financial reporting and taxable income arising from alternative minimum tax carryforwards, net operating loss (NOL) carryforwards, foreign tax credit carryforwards, depreciation and leveraged leases.

        Deferred tax liabilities and assets result primarily from the differences in the timing of the recognition for transactions between financial reporting and income tax purposes and consist of the following components:

 
 May 31,
 
 
 2004
 2003
 
Deferred tax assets-current attributable to:       
 Inventory costs $31,129 $30,594 
 Employee benefits (accruals)  (5,109) (3,234)
 Other  1,554  (70)
  
 
 
 Total deferred tax assets-current $27,574 $27,290 
  
 
 
Deferred tax assets-noncurrent attributable to:       
 Postretirement benefits (liabilities) $7,572 $9,013 
 Alternative minimum tax carryforwards, NOL carryforwards and foreign tax credit carryforwards  34,859  32,785 
 Valuation allowance  (1,576) (939)
  
 
 
 Total deferred tax assets-noncurrent $40,855 $40,859 
  
 
 
 Total deferred tax assets $68,429 $68,149 
  
 
 
Deferred tax liabilities attributable to:       
 Depreciation $(50,612)$(49,750)
 Leveraged leases  (7,871) (13,710)
  
 
 
 Total deferred tax liabilities $(58,483)$(63,460)
  
 
 
Net deferred tax assets $9,946 $4,689 
  
 
 

        During fiscal 2004 and 2003, we established deferred tax valuation allowances of $637 and $939, respectively, related to certain foreign tax credit carryforwards. For the other deferred tax assets, we have determined that the realization of the deferred tax assets is more likely than not, and that a valuation



allowance is not required based upon our prior history of operating earnings, the nature of certain of our deferred tax assets, our expectations for continued future earnings and the scheduled reversal of deferred tax liabilities, primarily related to depreciation.

        The provision (benefit) for income taxes differs from the amount computed by applying the U.S. federal statutory income tax rate of 35% for fiscal 2004, 2003 and 2002, for the following reasons:

 
 For the Year Ended May 31,
 
 
 2004
 2003
 2002
 
Provision (benefit) for income taxes at the federal statutory rate $597 $(6,820)$(34,380)
 Tax benefits on exempt earnings from export sales  (2,625) (1,220) (1,460)
 State income taxes, net of federal benefit and refunds  175  176  (1,267)
 Reduction in income tax accrued liabilities  (350)   (2,000)
 Valuation allowance  637  939   
 Other, net  (231) (155) (183)
  
 
 
 
Provision (benefit) for income taxes as reported $(1,797)$(7,080)$(39,290)
  
 
 
 

        During fiscal 2004 and 2002, we recorded reductions in income tax expense of $350 and $2,000, respectively. These adjustments represent the reversal of federal and state income tax accruals which were no longer considered required. The fiscal 2002 adjustment pertains primarily to amounts recorded during the fiscal years 1999 through 2001 related to incentives on exports and tax credits. A change in tax law effective in fiscal 2002 regarding the computation of export incentives, combined with previous experience with tax examinations, resulted in the reduction in the tax expense.

5.    Common Stock and Stock Options

We have established stock option plans for our officers and key employees. Stock optionprovide stock-based awards under the AAR CORP. Stock Benefit Plan typically(“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 under the plan expire ten years from the date of grant or earlier upon termination of employment, becomeand are exercisable in either four or five equal annual increments on successive grant anniversary dates atcommencing one year after the New York Stock Exchange closingdate of grant. We issue new common stock priceupon the exercise of stock options. In addition to stock options, the Stock Benefit Plan also provides for the issuance of restricted stock awards and performance based restricted stock awards, as well as for the granting of stock appreciation units; however, to date, no stock appreciation units have been granted.

Restricted stock grants are designed, among other things, to align employee interests with the interests of stockholders and to encourage the recipient to build a career with the Company. Restricted stock typically vests over periods of three to ten years from date of grant. Restricted stock grants may be performance-based with vesting to occur over periods of one to ten years after the grant is earned. All restricted stock which has not vested carries full dividend and voting rights.

Typically, stock options and restricted stock are subject to forfeiture prior to vesting if the employee terminates employment for any reason other than death, retirement or disability or if we terminate employment for cause. A total of 5,094 shares have been granted under the Stock Benefit Plan since its inception, and as of May 31, 2007, awards representing 3,368 shares were available for future grant under the Stock Benefit Plan.

Effective June 1, 2006, we adopted SFAS No. 123(R), using the modified prospective method of transition. Under SFAS No. 123(R), compensation expense is recognized for stock option grants made after May 31, 2006 and for the unvested portion of outstanding stock options that were granted prior to the adoption of SFAS No. 123(R). Compensation cost is measured based on the grant date fair value of the award and recognized on a straight line basis over the vesting period.

Prior to the adoption of SFAS No. 123(R), we accounted for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” and SFAS No. 123, “Accounting for Stock-Based Compensation”. Under APB 25, no compensation expense was recognized for stock option grants, and accordingly share-based compensation related to stock options granted prior to June 1, 2006 was included as pro forma disclosure in the consolidated financial statements.

On April 11, 2006, our Board of Directors approved the acceleration of the vesting of all unvested stock options. As a result of this action, stock options representing approximately 679 shares that were scheduled to vest in fiscal 2007, 2008 and 2009 became fully exercisable effective May 1, 2006. The


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

3.   Stock-Based Compensation (Continued)

accelerated vesting enabled us to reduce the amount of compensation expense that would otherwise be required to be recognized in our consolidated statements of operations with respect to these options upon the adoption of SFAS No. 123(R). The aggregate expense that was eliminated as a result of the acceleration was approximately $1,800. The acceleration resulted in a non-cash, one-time pre-tax stock compensation expense of $362 in the fourth quarter of fiscal 2006.

On June 1, 2006, we granted stock options representing 100 shares to a select group of key leadership track employees. No executive officers were included in the group that received stock option grants. No stock options were granted during fiscal 2006 and 2005 other than reload options, which resulted from the exercise of original stock options granted in prior years. Effective May 1, 2006, the reload provision was eliminated from substantially all outstanding stock option arrangements.

The weighted average fair value of stock options granted during fiscal 2007, 2006 and 2005 was $11.93, $3.71 and $2.87, 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:

 

 

Stock Options Granted
In Fiscal Year

 

 

 

2007

 

2006

 

2005

 

Risk-free interest rate

 

5.0

%

4.3

%

3.3

%

Expected volatility of common stock

 

58.7

%

34.1

%

45.6

%

Dividend yield

 

0.0

%

0.0

%

0.0

%

Expected option term in years

 

4.0

 

1.0

 

1.1

 

The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected volatility is based on historical volatility of our common stock and the expected option term represents the period of time that the stock options granted are accompanied by reload featuresexpected to be outstanding based on historical exercise trends. The dividend yield represents our anticipated cash dividends over the expected option term.

The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to our stock option plan for certain individuals, stock rights exercisable in the event of a change in control of the Company.years ended May 31, 2006 and 2005.

 

 

For the Year Ended
May 31,

 

 

 

2006

 

2005

 

Net income as reported

 

$

35,163

 

$

15,453

 

Add: Stock-based compensation expense included in net income as reported, net of tax

 

2,634

 

1,540

 

Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of tax

 

(6,464

)

(5,170

)

Pro forma net income

 

$

31,333

 

$

11,823

 

Earnings per share—basic:

As reported

 

$

1.05

 

$

0.48

 

 

Pro forma

 

$

0.94

 

$

0.37

 

Earnings per share—diluted:

As reported

 

$

0.94

 

$

0.46

 

 

Pro forma

 

$

0.84

 

$

0.36

 


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

3.   Stock-Based Compensation (Continued)

The adoption of SFAS No. 123(R) on June 1, 2006 reduced our operating income from continuing operations by $240 for the year ended May 31, 2007.

A summary of changes in stock options (in thousands) granted to officers, key employees and nonemployee directors under stock option plansactivity for the three years ended May 31, 2004 follows:2007 follows (shares in thousands):

 
 Number of
Shares

 Weighted Average
Exercise Price

Outstanding, May 31, 2001 (2,355 exercisable) 4,068 $16.79
 Granted 937  14.95
 Exercised (129) 10.15
 Surrendered/expired/cancelled (628) 18.10
  
   
Outstanding, May 31, 2002 (2,495 exercisable) 4,248  16.51
 Granted 943  8.45
 Exercised   
 Surrendered/expired/cancelled (589) 13.28
  
   
Outstanding, May 31, 2003 (2,754 exercisable) 4,602  15.27
 Granted 1,524  9.32
 Exercised (785) 9.75
 Surrendered/expired/cancelled (187) 15.31
  
   
Outstanding, May 31, 2004 (3,390 exercisable) 5,154 $14.35
  
   

 

 

2007

 

2006

 

2005

 

 

 

 

 

Weighted

 

 

 

Weighted

 

 

 

Weighted

 

 

 

 

 

Average

 

 

 

Average

 

 

 

Average

 

 

 

 

 

Exercise

 

 

 

Exercise

 

 

 

Exercise

 

 

 

Shares

 

Price

 

Shares

 

Price

 

Shares

 

Price

 

Oustanding at beginning of year

 

3,080

 

 

$

16.88

 

 

4,607

 

 

$

15.17

 

 

5,154

 

 

$

14.35

 

 

Granted

 

100

 

 

$

24.08

 

 

364

 

 

$

22.28

 

 

845

 

 

$

14.66

 

 

Exercised

 

(1,021

)

 

$

17.72

 

 

(1,818

)

 

$

13.70

 

 

(1,186

)

 

$

11.03

 

 

Cancelled

 

(24

)

 

$

17.47

 

 

(73

)

 

$

15.19

 

 

(206

)

 

$

16.37

 

 

Outstanding at end of year

 

2,135

 

 

$

18.30

 

 

3,080

 

 

$

16.88

 

 

4,607

 

 

$

15.17

 

 

Options exercisable at end of year

 

2,038

 

 

$

18.03

 

 

3,080

 

 

$

16.88

 

 

3,414

 

 

$

17.48

 

 

 

The total fair value of stock options that vested during fiscal 2007, 2006 and 2005 was $0, $1,628 and $818, respectively. The total intrinsic value of stock options exercised during fiscal 2007, 2006 and 2005 was $13,582, $17,148 and $4,315, respectively. The aggregate intrinsic value of options outstanding as of May 31, 2007 was $30,255. The tax benefit realized from stock options exercised during fiscal 2007 and 2006 was $4,345 and $7,553, respectively. As of May 31, 2007, we had $953 of unrecognized compensation expense related to stock options that will be amortized over an average period of five years.

The following table provides additional information regarding stock options (in thousands) outstanding as of May 31, 2004:2007 (shares in thousands):

 
Option
Exercise
Price Range

 Options
Outstanding

 Weighted Average
Remaining Contractual
Life of Options (Years)

 Number of
Options
Exercisable

 Weighted Average
Exercise Price of
Options Exercisable

 $3.06 – 12.25 2,090 7.5 731 $10.55
 $12.26 – 18.38 1,958 5.1 1,607 $15.58
 $18.39 – 24.50 1,079 4.0 1,025 $23.19
 $24.51 – 30.63 27 2.0 27 $27.56
    
   
   
    5,154 5.8 3,390 $16.90
    
   
   

 

 

Options Outstanding

 

Options Exercisable

 

 

 

 

 

Weighted-

 

 

 

 

 

 

 

 

 

 

 

Average

 

Weighted-

 

 

 

Weighted-

 

Option

 

Number

 

Remaining

 

Average

 

Number

 

Average

 

Exercise

 

Outstanding as

 

Contractual

 

Exercise

 

Exercisable as

 

Exercise

 

Price Range

 

of 5/31/07

 

Life in Years

 

Price

 

of 5/31/07

 

Price

 

$3.20—$13.00

 

 

304

 

 

 

5.9

 

 

 

$

7.51

 

 

 

304

 

 

 

$

7.51

 

 

$13.01—$18.50

 

 

783

 

 

 

4.1

 

 

 

$

15.95

 

 

 

783

 

 

 

$

15.95

 

 

$18.51—$24.50

 

 

955

 

 

 

5.0

 

 

 

$

23.12

 

 

 

858

 

 

 

$

23.01

 

 

$24.51—$29.00

 

 

93

 

 

 

3.3

 

 

 

$

26.26

 

 

 

93

 

 

 

$

26.26

 

 

 

 

 

2,135

 

 

 

4.7

 

 

 

$

18.30

 

 

 

2,038

 

 

 

$

18.03

 

 

 The

42




AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

3.   Stock-Based Compensation (Continued)

Restricted Stock Benefit Plan also provides for

We provide executives and other key employees an opportunity to be awarded restricted shares. The award is contingent upon the grantachievement of certain performance objectives, including net income and return on capital, or the Company’s stock price achieving a certain level over a period of time. After the shares are granted, the restrictions are released over a five to seven year period. During fiscal 2007, 2006 and 2005, we granted 459, 438 and 150 restricted shares, respectively, under this program.

In addition to the performance-based restricted stock awards. Restrictions are released at the endawards, we also granted a total of applicable restriction periods. The number of21 restricted shares and the restricted period, which varies from three to ten years, are determined by the Compensation Committeemembers of the Board of Directors. At the dateDirectors and one non-executive employee during fiscal 2007.

The fair value of grant,restricted shares is the market value of the award (basedour common stock on the New York Stock Exchange common stock closing price)date of grant. Amortization expense related to all restricted shares during fiscal 2007, 2006 and 2005 was $3,458, $3,690 and $1,263 respectively.

Restricted share activity during the fiscal year ended May 31, 2007 is recorded in common stock and capital surplus; an offsetting amount is recorded as a componentfollows:

 

 

Number
of Shares

 

Weighted Average
Fair Value
on Grant Date

 

Nonvested at May 31, 2006

 

 

785

 

 

 

$

15.06

 

 

Granted

 

 

480

 

 

 

$

32.91

 

 

Vested

 

 

(195

)

 

 

$

14.20

 

 

Forfeited

 

 

(3

)

 

 

$

15.88

 

 

Nonvested at May 31, 2007

 

 

1,067

 

 

 

$

23.16

 

 

As of stockholders' equityMay 31, 2006, unearned compensation related to restricted shares was included in unearned restricted stock awards. The number (in thousands)awards, a separate component of stockholders’ equity. Upon the adoption of SFAS No. 123(R), the balance was reclassified to capital surplus. As of May 31, 2007, we had $16,538 of unearned compensation related to restricted shares awardedthat will be amortized to officers and key employees and theexpense over a weighted average per share fair valueperiod of those shares are as follows:

 
 For the Year Ended May 31,
 
 2004
 2003
 2002
Shares of restricted stock granted  202   10
Weighted average per share fair value $6.96  $8.70

        Compensation cost is included in results of operations over the vesting period. Expense (income) relating to outstanding restricted stock awards for the three-year period ended May 31, 2004 follows:

 
 For the Year Ended May 31,
 
 
 2004
 2003
 2002
 
Expense $516 $330 $571 
Forfeitures (income)  (17) (111) (802)
  
 
 
 
Net $499 $219 $(231)
  
 
 
 

        The AAR CORP. Employee Stock Purchase Plan is open to our employees (other than officers, directors or participants in our other stock option plans) and permits employees to purchase common stock in periodic offerings through payroll deductions.2.9 years.

        All equity compensation plans have been approved by shareholders. The number of options and awards outstanding and available for grant or issuance for each of our stock plans are as follows (in thousands):Shareholders’ Rights Plan

 
 May 31, 2004
 
 Outstanding
 Available
 Total
Stock Benefit Plan (officers, directors and key employees) 5,718 1,719 7,437
Employee Stock Purchase Plan  144 144

Pursuant to a shareholder rights plan adopted in 1997, each outstanding share of our common stock carries with it a Right to purchase one and one half additional shares at a price of $83.33 per share. The Rights become exercisable (and separate from the shares) when certain specified events occur, including the acquisition of 15% or more of the common stock by a person or group (an "Acquiring Person"“Acquiring Person”) or the commencement of a tender or exchange offer for 15% or more of the common stock.

In the event that an Acquiring Person acquires 15% or more of the common stock, or if we are the surviving corporation in a merger involving an Acquiring Person or if the Acquiring Person engages in certain types of self-dealing transactions, each Right entitles the holder to purchase for $83.33 per share (or the then-current exercise price), shares of our common stock having a market value of $166.66 (or two times the exercise price), subject to certain exceptions. Similarly, if we are acquired in a merger or other business combination or 50% or more of our assets or earning power is sold, each Right entitles the holder to purchase at the then-current exercise price that number of shares of common stock of the surviving


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

3.   Stock-Based Compensation (Continued)

corporation having a market value of two times the exercise price. The Rights do not entitle the holder thereof to vote or to receive dividends. The Rights will expire on August 6, 2007, and may be redeemed by us for $.01 per Right under certain circumstances. On July 10, 2007, our Board of Directors adopted a new Shareholders’ Rights plan effective August 7, 2007.

On September 21, 1990, theJune 20, 2006 our Board of Directors authorized us to purchase up to 1,500,000 shares (adjusted for a three-for-two stock split) of our common stock on the open market or through privately negotiated transactions. On October 13, 1999, the Board of Directors authorized us to purchase up to 1,500,000 additional shares of our common stock. As of May 31, 2004, we had purchased 1,745,0001,500 shares of our common stock on the open market under these programs at an average price of $14.00 per share and havemarket. This action superseded our previous stock repurchase plan which had remaining authorization to purchase 1,255,000 shares (see Note 3).1,255 shares.

4.   Income Taxes

Our pre-tax income was substantially from domestic activities. The provision for income taxes on continuing operations includes the following components:

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Current:

 

 

 

 

 

 

 

Federal

 

$

6,863

 

$

1,355

 

$

1,034

 

State

 

700

 

900

 

420

 

 

 

7,563

 

2,255

 

1,454

 

Deferred

 

20,411

 

8,433

 

2,112

 

 

 

$

27,974

 

$

10,688

 

$

3,566

 

The deferred tax provision results primarily from differences between financial reporting and taxable income arising from depreciation and leveraged leases.

The provision for income taxes on continuing operations differs from the amount computed by applying the U.S. federal statutory income tax rate of 35% for fiscal 2007, 2006 and 2005 to income before taxes, for the following reasons:

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Provision for income taxes at the federal statutory rate

 

$

30,597

 

$

16,279

 

$

8,073

 

Tax benefits on exempt earnings from export sales

 

(3,257

)

(5,806

)

(3,430

)

State income taxes, net of federal benefit and refunds

 

455

 

585

 

270

 

Changes in valuation allowance

 

 

 

(1,575

)

Reduction in income tax accrued liabilities and other

 

179

 

(370

)

228

 

Provision for income taxes on continuing operations

 

$

27,974

 

$

10,688

 

$

3,566

 

In October of 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law and included a number of Federal income tax reforms, including the phase-out of tax benefits on earnings from export sales. This benefit was eliminated effective December 31, 2006 resulting in a lower benefit on exempt earnings from export sales during fiscal 2007.

During the third quarter of fiscal 2006, upon completion of our fiscal 2005 Federal income tax return, we determined that the Company qualified for additional tax benefits of $1,606 related to higher than


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

6.4.   Income Taxes (Continued)

estimated margin on fiscal 2005 export activities. Similarly, we recorded a $496 benefit during the third quarter of fiscal 2005 which primarily related to additional tax benefits from fiscal 2004 export activities.

Deferred tax liabilities and assets result primarily from the differences in the timing of the recognition of transactions for financial reporting and income tax purposes and consist of the following components:

 

 

May 31,

 

 

 

2007

 

2006

 

Deferred tax assets-current attributable to:

 

 

 

 

 

Inventory costs

 

$

24,162

 

$

26,099

 

Employee benefits (accruals)

 

(878

)

(175

)

Allowance for doubtful accounts

 

1,293

 

1,473

 

Advanced billings and other

 

936

 

2,469

 

Total deferred tax assets-current

 

$

25,513

 

$

29,866

 

Deferred tax assets-noncurrent attributable to:

 

 

 

 

 

Postretirement benefits (liabilities)

 

$

8,366

 

$

7,495

 

Alternative minimum tax carryforwards, NOL carryforwards and foreign tax credit carryforwards

 

1,063

 

16,545

 

Total deferred tax assets-noncurrent

 

$

9,429

 

$

24,040

 

Total deferred tax assets

 

$

34,942

 

$

53,906

 

Deferred tax liabilities attributable to:

 

 

 

 

 

Depreciation

 

$

(43,031

)

$

(42,345

)

Leveraged leases

 

(6,518

)

(7,052

)

Total deferred tax liabilities

 

$

(49,549

)

$

(49,397

)

Net deferred tax assets (liabilities)

 

$

(14,607

)

$

4,509

 

As of May 31, 2007, we have determined that the realization of our deferred tax assets is more likely than not, and that a valuation allowance is not required based upon our history of operating earnings, the nature of certain of our deferred tax assets, our expectations for continued future earnings and the scheduled reversal of deferred tax liabilities, primarily related to depreciation.

5.   Earnings Per Share

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

In the third quarter of fiscal 2005, we adopted the provisions of Emerging Issues Task Force Issue No. 04-08, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share” (“EITF No. 04-08”), which requires companies to use the “if converted” method set forth in SFAS No. 128, “Earnings Per Share,” for calculating diluted earnings per share when contingently convertible debt is


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

5.   Earnings Per Share (Continued)

outstanding. 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. For comparative purposes, diluted earnings per share information for all periods since the convertible debt securities were issued in February 2004 have been restated as required by EITF No. 04-08.

The following table provides a reconciliation of the computations of basic and diluted earnings per share information for each of the years in the three-year period ended May 31, 2004 (in2007 (shares in thousands).

 
 For the Year Ended May 31,
 
 
 2004
 2003
 2002
 
Basic:          
 Net income (loss) $3,504 $(12,410)$(58,939)
 Average shares of common stock outstanding  32,111  31,852  28,282 
 Earnings (loss) per share of common stock-basic $0.11 $(0.39)$(2.08)
  
 
 
 
Diluted:          
 Net income (loss) $3,504 $(12,410)$(58,939)
 Average shares of common stock outstanding  32,111  31,852  28,282 
 Additional shares due to hypothetical exercise of stock options  281     
  
 
 
 
 Average shares of common stock outstanding-diluted  32,392  31,852  28,282 
 Earnings (loss) per share-diluted $0.11 $(0.39)$(2.08)
  
 
 
 

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Income from continuing operations

 

$

59,447

 

$

35,823

 

$

19,498

 

Loss from discontinued operations, net of tax

 

(787

)

(660

)

(4,045

)

Net income

 

$

58,660

 

$

35,163

 

$

15,453

 

Basic shares:

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

36,389

 

33,530

 

32,297

 

Earnings per share—basic:

 

 

 

 

 

 

 

Earnings from continuing operations

 

$

1.63

 

$

1.07

 

$

0.60

 

Loss from discontinued operations, net of tax

 

(0.02

)

(0.02

)

(0.12

)

Earnings per share—basic

 

$

1.61

 

$

1.05

 

$

0.48

 

Net income

 

$

58,660

 

$

35,163

 

$

15,453

 

Add: After-tax interest on convertible debt

 

1,965

 

1,461

 

1,230

 

Net income for diluted EPS calculation

 

$

60,625

 

$

36,624

 

$

16,683

 

Diluted shares:

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

36,389

 

33,530

 

32,297

 

Additional shares from the assumed exercise of stock options

 

445

 

487

 

304

 

Additional shares from the assumed vesting of restricted stock

 

499

 

473

 

 

Additional shares from the assumed conversion of convertible debt

 

5,976

 

4,362

 

3,604

 

Weighted average common shares outstanding—diluted

 

43,309

 

38,852

 

36,205

 

Earnings per share—diluted:

 

 

 

 

 

 

 

Earnings from continuing operations

 

$

1.42

 

$

0.96

 

$

0.57

 

Loss from discontinued operations, net of tax

 

(0.02

)

(0.02

)

(0.11

)

Earnings per share—diluted

 

$

1.40

 

$

0.94

 

$

0.46

 

 

At May 31, 20042007, 2006 and 20032005, respectively, stock options to purchase 3,234,00031 thousand, 1.2 million and 4,571,0003.4 million shares of common stock were outstanding, but were not included in the computation of diluted earnings per share, because the exercise price of these options was greater than the average market price of the common shares.

        Common stock equivalents representing options to purchase 31,000 shares for year ended May 31, 2003 were not included46




AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in the computation of diluted earningsthousands, except per share because to do so would have been antidilutive due to the net loss during the period.amounts)

7.6.   Employee Benefit Plans

We have defined contribution and defined benefit plans covering substantially all full-time domestic employees and certain employees in The Netherlands. In addition, we provide postretirement health and life insurance benefits to eligible domestic employees.

Defined Benefit Plans

Prior to January 1, 2000, the pension plan for domestic salaried and non-union hourly employees had a benefit formula based primarily on years of service and compensation. Effective January 1, 2000, we converted our existing defined benefit plan for substantially all domestic salaried and certain hourly employees to a cash balance pension plan. Under the cash balance pension plan, the retirement benefit is expressed as a dollar amount in an account that grows with annual pay-based credits and interest on the account balance. The interest crediting rate under our cash balance plan is determined quarterly and is equal to 100% of the average 30-year treasury rate for the second month preceding the applicable quarter published by the Internal Revenue Service. The average interest crediting rate under our cash balance plan for the fiscal year ended May 31, 2007 was 4.93%. Effective June 1, 2005, the existing cash balance plan was frozen and the annual pay-based credits were discontinued. During the fourth quarter of fiscal 2005, we recorded a $667 curtailment loss associated with this change to the cash balance plan. Also effective June 1, 2005, the defined contribution plan was modified to include increased employer contributions and an enhanced profit sharing formula. Defined pension benefits for certain union hourly employees are based primarily on a fixed amount per year of service.


Certain foreign operations of domestic subsidiaries also have a pension plan which is a defined benefit plan. Benefit formulas are based generally on years of service and compensation. It is the policy of these subsidiaries to fund at least the minimum amounts required by local laws and regulations.

We provide oureligible outside directors with benefits upon retirement on or after age 65 provided they have completed at least five years of service as a director. Benefits are paid quarterly in cash equal to 25% of the annual retainer fee payable to active outside directors. Payment of benefits commence upon retirement and continues for a period equal to the total number of years of the retired director'sdirector’s service up to a maximum of ten years, or death, whichever occurs first. In the fourth quarter of fiscal 2001, we terminated the plan for any new members of the Board of Directors elected after May 31, 2001.

We also provide supplemental retirement and profit sharing benefits for current and former executives and key employees to supplement benefits provided by our other benefit plans. The plans are not

Effective May 31, 2007, we adopted the provisions of SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”. SFAS No. 158 requires employers to recognize the overfunded or underfunded status of a defined benefit pension or other postretirement plan as an asset or liability in its statement of financial position, recognize changes in that funded and may require fundingstatus in the event ofyear in which the changes occur through comprehensive income and measure a change in controlplan’s assets and its obligations that determine its funded status as of the Companyend of the employer’s fiscal year. We have historically measured the plan assets and liabilities as determined byof our Board of Directors.balance sheet date.


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

6.   Employee Benefit Plans (Continued)

Obligations and Funded Status

The following table sets forth the changechanges in projected benefit obligations and plan assets for all of our pension plans:



 May 31,
 

 

May 31,

 



 2004
 2003
 

 

2007

 

2006

 

Change in benefit obligation:Change in benefit obligation:     

 

 

 

 

 

Benefit obligation at beginning of year $77,425 $67,264 
Service cost 2,834 2,726 
Interest cost 4,483 4,458 
Plan participants' contributions 223 213 
Amendments  688 
Net actuarial (gain) loss (3,795) 7,184 
Benefits paid (4,126) (5,108)
 
 
 

Benefit obligation at beginning of year

 

$

84,427

 

$

90,829

 

Service cost

 

1,322

 

1,567

 

Interest cost

 

5,058

 

4,717

 

Plan participants’ contributions

 

271

 

252

 

Amendments

 

 

104

 

Net actuarial loss (gain)

 

(436

)

(7,141

)

Benefits paid

 

(5,835

)

(5,901

)

Translation

 

4,640

 

 

Benefit obligation at end of yearBenefit obligation at end of year $77,044 $77,425 

 

$

89,447

 

$

84,427

 

 
 
 

Change in plan assets:

 

 

 

 

 

Fair value of plan assets at beginning of year

 

$

75,121

 

$

69,859

 

Actual return on plan assets

 

8,471

 

6,731

 

Employer contributions

 

2,947

 

4,180

 

Plan participants’ contributions

 

271

 

252

 

Benefits paid

 

(5,835

)

(5,901

)

Translation

 

5,070

 

 

Fair value of plan assets at end of year

 

$

86,045

 

$

75,121

 

Funded status at end of year

 

$

(3,402

)

$

(9,306

)

Unrecognized actuarial losses

 

 

 

24,416

 

Unrecognized prior service cost

 

 

 

1,021

 

Accumulated other comprehensive loss—minimum pension liability

 

 

 

(20,159

)

Net amount recognized

 

 

 

$

(4,028

)

 

Amounts recognized in the consolidated balance sheets consisted of the following:

 

 

May 31,

 

 

 

2007

 

2006

 

Deposits, prepaids and other

 

$

 

$

2,633

 

Other assets

 

3,456

 

16,820

 

Accrued liabilities

 

(2,450

)

(3,322

)

Other liabilities and deferred income

 

(4,408

)

 

 

 

$

(3,402

)

$

16,131

 


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

6.   Employee Benefit Plans (Continued)

Amounts recognized in accumulated comprehensive loss, net of tax consisted of the following:

 

 

May 31,

 

 

 

2007

 

2006

 

Actuarial loss

 

$

13,683

 

$

 

Prior service cost

 

571

 

 

Minimum pension liability

 

 

13,103

 

Total

 

$

14,254

 

$

13,103

 

Prior to the adoption of SFAS No. 158, a minimum pension liability adjustment was required when the actuarial present value of accumulated plan benefits exceeded plan assets and accrued pension liabilities. During fiscal 2007, we reduced the minimum pension liability by $3,104, and $1,921, net of tax, was reported as a component of comprehensive income.

Information for pension plans with an accumulated benefit obligation in excess of plan assets was as follows:

 

 

May 31,

 

 

 

2007

 

2006

 

Projected benefit obligation

 

$

65,027

 

$

63,963

 

Accumulated benefit obligation

 

64,381

 

63,077

 

Fair value of plan assets

 

58,170

 

53,307

 

The accumulated benefit obligation for all pension plans was $82,820 and $82,077 as of May 31, 2007 and 2006, respectively.

Net Periodic Benefic Cost

Pension expense charged to results of operations includes the following components:

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Service cost

 

$

1,322

 

$

1,567

 

$

2,841

 

Interest cost

 

5,058

 

4,717

 

4,899

 

Expected return on plan assets

 

(6,029

)

(5,764

)

(5,701

)

Amortization of prior service cost

 

109

 

112

 

295

 

Recognized net actuarial loss

 

633

 

1,052

 

1,155

 

Transitional obligation

 

 

 

68

 

Curtailment

 

 

 

667

 

Settlement charge

 

201

 

156

 

 

 

 

$

1,294

 

$

1,840

 

$

4,224

 


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

6.   Employee Benefit Plans (Continued)

Adoption of SFAS No. 158

Effective May 31, 2007, we adopted the provisions of SFAS No. 158. The incremental effect of applying SFAS No. 158 for all of our plans on individual line items in the consolidated balance sheet as of May 31, 2007 was as follows:

 

 

Before Application
of SFAS No. 158

 

Adjustments
Increase (Decrease)

 

After Application
of SFAS No. 158

 

Deposits, prepaids and other

 

 

$

17,096

 

 

 

$

(4,489

)

 

 

$

12,607

 

 

Other assets

 

 

84,268

 

 

 

(14,614

)

 

 

69,654

 

 

Total assets

 

 

1,086,736

 

 

 

(19,103

)

 

 

1,067,633

 

 

Accrued liabilities

 

 

90,640

 

 

 

(18,618

)

 

 

72,022

 

 

Deferred tax liabilities

 

 

42,026

 

 

 

(1,905

)

 

 

40,121

 

 

Other liabilities and deferred income

 

 

18,194

 

 

 

4,958

 

 

 

23,152

 

 

Accumulated other comprehensive loss

 

 

(10,362

)

 

 

(3,537

)

 

 

(13,899

)

 

Stockholders’ equity

 

 

497,780

 

 

 

(3,537

)

 

 

494,243

 

 

Assumptions

The assumptions used in accounting for the Company’s plans are estimates of factors including, among other things, the amount and timing of future benefit payments. The following table presents the key assumptions used in the measurement of the Company’s benefit obligations:

 

 

May 31,

 

 

 

2007

 

2006

 

Domestic plans:

 

 

 

 

 

Discount rate

 

6.05

%

6.40

%

Rate of compensation increase

 

3.50

 

3.50

 

 

 

May 31,

 

 

 

2007

 

2006

 

Non-domestic plans:

 

 

 

 

 

Discount rate

 

5.10

%

4.75

%

Rate of compensation increase

 

3.00

 

3.00

 


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

6.   Employee Benefit Plans (Continued)

A summary of the weighted average assumptions used to determine net periodic pension expense is as follows:

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Domestic plans:

 

 

 

 

 

 

 

Discount rate

 

6.40

%

5.40

%

6.50

%

Rate of compensation increase

 

3.50

 

3.00

 

3.00

 

Expected long-term return on plan assets

 

8.50

 

8.50

 

8.50

 

Non-domestic plans:

 

 

 

 

 

 

 

Discount rate

 

4.75

%

4.25

%

5.50

%

Rate of compensation increase

 

3.00

 

3.00

 

3.25

 

Expected long-term return on plan assets

 

6.50

 

6.50

 

6.50

 

The discount rate was determined by projecting the plan’s expected future benefit payments as defined for the projected benefit obligation, is measured at May 31discounting those expected payments using a theoretical zero-coupon spot yield curve derived from a universe of each year usinghigh-quality bonds as of the following weighted average assumptions:

 
 May 31,
 
 
 2004
 2003
 
Domestic plans:     
 Discount rate 6.50%6.00%
 Compensation increase rate 3.00 3.00 
Non-domestic plans:     
 Discount rate 5.50%5.25%
 Compensation increase rate 3.25 3.25 

        The following table sets forthmeasurement date, and solving for the changesingle equivalent discount rate that resulted in fair valuethe same projected benefit obligation. Constraints were applied with respect to callability and credit quality. In addition, 3% of plan assets:the bonds were deemed outliers due to questionable pricing information and consequently were excluded from consideration.

 
 May 31,
 
 
 2004
 2003
 
Change in plan assets:       
 Fair value of plan assets at beginning of year $51,431 $50,067 
 Actual return on plan assets  6,407  (564)
 Employer contributions  6,899  6,823 
 Plan participants' contributions  223  213 
 Benefits paid  (4,126) (5,108)
  
 
 
Fair value of plan assets at end of year $60,834 $51,431 
  
 
 

Plan Assets

The following table sets forth the actual asset allocation and target allocations for our U.S. pension plans:


 May 31,
  
 

 Target Asset
Allocation

 

 

May 31,

 

Target Asset

 


 2004
 2003
 

 

2007

 

2006

 

Allocation

 

Equity securities 65%48%45 – 65%

 

 

67

%

 

 

65

%

 

 

45–75

%

 

Fixed income securities 29 52 25 – 55%

 

 

21

 

 

 

27

 

 

 

25–55

%

 

Other (fund-of funds hedge fund) 6  0 – 20%

 

 

12

 

 

 

8

 

 

 

0–20

%

 

 
 
   

 

 

100

%

 

 

100

%

 

 

 

 

 

 100%100%  
 
 
   

 

The assets of U.S pension plans are invested in compliance with the Employee Retirement Income Security Act of 1974 (ERISA). The investment goals are to provide a total return that, over the long term, optimizes the long-term return on plan assets at an acceptable risk, and to maintain a broad diversification across asset classes and among investment managers. Direct investments in our securities and the use of derivatives for the purpose of speculation are not permitted. The assets of the U.S. pension plans are invested primarily in equity and fixed income mutual funds, and individual common stocks and investments in fiscal 2004, included an investment in a fund-of funds hedge fund.funds.

The assets of the non-domestic plan are invested in compliance with local laws and regulations and are comprised of insurance contracts and equity and fixed income mutual funds.

51




AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

6.   Employee Benefit Plans (Continued)

To develop our expected long-term rate of return assumption on domestic plans, we use long-term historical return information for our targeted asset mix and current market conditions.

Cash Flow

The expected long-term rate of return assumption used in computingfollowing table summarizes our estimated future pension benefits by fiscal 2004 net periodic pension expense was 8.5% for the domestic plans and 6.5% for the non-domestic plan.year:

 

 

Fiscal Year

 

 

 

2008

 

2009

 

2010

 

2011

 

2012

 

2013 to 2017

 

Estimated pension benefits

 

$

7,022

 

$

5,535

 

$

5,523

 

$

5,504

 

$

5,668

 

 

$

29,217

 

 

Our contribution policy for the domestic plans is to contribute annually, at a minimum, an amount which is deductible for federal income tax purposes and that is sufficient to meet actuarially computed pension benefits. We anticipate contributing $4,000$2,000 to $7,000$4,000 during fiscal 2005.2008.



Additional Information

The following table sets forth all of the defined benefit plan's funded status and the amount recognized inestimated amounts for our Consolidated Balance Sheets:

 
 May 31,
 
 
 2004
 2003
 
 Funded status $(16,210)$(25,994)
 Unrecognized actuarial losses  25,886  31,800 
 Unrecognized prior service cost  1,773  2,146 
 Unrecognized transitional obligation  67  151 
  
 
 
Prepaid pension costs $11,516 $8,103 
  
 
 

        A minimum pension liability adjustment is required when the actuarial present value ofplans that will be amortized from accumulated plan benefits exceeds plan assets and accrued pension liabilities. During fiscal 2003, we recorded a $14,334 increase to the minimum pension liability, and $9,270, net of tax, was reported as a component ofother comprehensive income (loss). Duringinto expense over the next fiscal 2004, we reduced the minimum pension liability by $3,909, and $2,677, net of tax, was reported as a component of comprehensive income.

        Pension expense charged to results of operations includes the following components:

 
 For the Year Ended May 31,
 
 
 2004
 2003
 2002
 
Service cost $2,834 $2,726 $2,767 
Interest cost  4,483  4,458  4,427 
Expected return on plan assets  (4,886) (4,804) (4,901)
Amortization of prior service cost  298  290  393 
Recognized net actuarial loss  1,392  504  112 
Transitional obligation  89  92  89 
Curtailment      311 
  
 
 
 
  $4,210 $3,266 $3,198 
  
 
 
 

        A summary of the weighted average assumptions used to determine net periodic pension expense isyear are as follows:

 
 For the Year Ended May 31,
 
 
 2004
 2003
 2002
 
Domestic plans:       
 Discount rate 6.00%7.25%7.75%
 Rate of compensation increase 3.00 4.00 4.50 
 Expected long-term return on plan assets 8.50 9.00 10.00 
Non-domestic plans:       
 Discount rate 5.25%6.00%6.00%
 Rate of compensation increase 3.25 4.00 4.00 
 Expected long-term return on plan assets 6.50 6.50 6.50 

Amortization of net actuarial loss

 

$

727

 

Amortization of prior service cost

 

$

148

 


Defined Contribution Plan

        The defined contribution plan is a profit sharing plan which is intended to qualify as a 401(k) plan under the Internal Revenue Code. Under the plan, employees may contribute up to 50% of their pretax compensation, subject to applicable regulatory limits. We may make matching contributions up to 5% of compensation. Company contributions vest on a pro-rata basis during the first three years of employment. During fiscal 2003, Company matching contributions to our defined contribution plan were suspended due to the operating performance of the Company. Expense charged to results of operations for Company matching contributions was $0, $457 and $1,391 in fiscal 2004, 2003 and 2002, respectively.

Postretirement Benefits Other Than Pensions

We provide health and life insurance benefits for certain eligible employees and retirees. The postretirement plans are unfunded, and we have the right to modify or terminate any of these plans in the future, in certain cases, subject to union bargaining agreements. In fiscal 1995, we completed termination of postretirement health and life insurance benefits attributable to future services of collective bargaining and other domestic employees.

        Postretirement benefit expense for the years ended May 31, 2004, 2003 and 2002 included the following components:

 
 For the Year Ended May 31,
 
 2004
 2003
 2002
Interest cost $47 $58 $97
Amortization of prior service cost  8  7  16
  
 
 
  $55 $65 $113
  
 
 

The funded status of the plans at May 31, 2004 and 2003 was as follows:

 
 May 31,
 
 
 2004
 2003
 
Change in benefit obligation:       
 Benefit obligation at beginning of year $847 $1,340 
 Interest cost  47  58 
 Benefits paid  (120) (116)
 Unrecognized actuarial loss  476  50 
 Amendment    (485)
 Plan participants' contributions     
  
 
 
Benefit obligation at end of year $1,250 $847 
  
 
 
Change in plan assets:       
 Fair value of plan assets at beginning of year $ $ 
 Company contributions  120  116 
 Benefits paid  (120) (116)
 Plan participants' contributions     
  
 
 
Fair value of plan assets at end of year $ $ 
  
 
 
 Funded status $(1,250)$(847)
 Unrecognized actuarial gain (loss)  504  (22)
 Unrecognized prior service cost  63  70 
  
 
 
Accrued postretirement costs $(683)$(799)
  
 
 

        The assumed discount rate used to measure the accumulated postretirementunfunded projected benefit obligation for this plan was 6.5% at May 31, 2004$1,370 and 6.0% at May 31, 2003. The assumed rate of future increases in healthcare costs was 10.0% and 9.0% in fiscal 2004 and 2003, respectively, declining to 5.0% by the year 2010 and remaining at that rate thereafter. A one percent increase in the assumed healthcare cost trend rate would increase the accumulated postretirement benefit obligation by approximately $46$1,363 as of May 31, 2004,2007 and would2006, respectively. We have omitted substantially all of the required disclosures related to this plan because the plan is not resultmaterial to our consolidated financial position or results of operations. Effective May 31, 2007, we adopted the provisions of SFAS No. 158 for this plan resulting in an increase to comprehensive loss of $465, net of tax.

Defined Contribution Plan

The defined contribution plan is a significant changeprofit sharing plan which is intended to qualify as a 401(k) plan under the Internal Revenue Code. Under the plan, employees may contribute up to 75% of their pretax compensation, subject to applicable regulatory limits. We may make matching contributions up to 5% of compensation as well as discretionary profit sharing contributions. Company contributions vest on a pro-rata basis during the first three years of employment. Expense charged to results of operations for Company matching contributions, including profit sharing contributions, was $5,501 in fiscal 2007, $4,216 in fiscal 2006 and $897 in fiscal 2005.


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

7.   Aircraft Joint Ventures

We have invested in limited liability companies that are accounted for under the equity method of accounting. Our membership interest in these limited liability companies is 50% and the primary business of these companies is the acquisition, ownership, lease and disposition of certain narrow-body commercial aircraft. Acquired aircraft are purchased with cash contributions by the members of the companies and debt financing provided on a limited recourse basis. Twelve aircraft are held in the joint ventures at May 31, 2007. Under the terms of a servicing agreement 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 annual postretirementdivestiture of aircraft by the limited liability companies. During fiscal 2007, 2006 and 2005, we were paid $1,115, $574 and $229, respectively, for such services. The income tax benefit expense.or expense related to the operations of the ventures is recorded by the member companies.

8.    Aviation Equipment Operating Leases

        From time to time we lease aviation equipment (engines and aircraft)Distributions from lessors under arrangements thatjoint ventures are classified as operating leases. or investing activities in the statement of cash flows based upon an evaluation of the specific facts and circumstances of each distribution to determine its nature.

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

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Statement of operations information:

 

 

 

 

 

 

 

Sales

 

$

81,626

 

$

28,857

 

$

11,249

 

Income before provision for income taxes

 

16,877

 

3,314

 

1,136

 

 

 

May 31,

 

 

 

2007

 

2006

 

Balance sheet information:

 

 

 

 

 

Assets

 

$

117,185

 

$

123,177

 

Debt

 

80,425

 

64,934

 

Members’ capital

 

31,603

 

54,949

 

We may also subleasehave an investment in an aircraft joint venture company that we consolidate. We consolidate the aviationfinancial position and results of operations of this joint venture because we are the primary beneficiary of the joint venture. The equity interest of the other partner in the joint venture is recorded as a minority interest, which was included in other non-current liabilities at May 31, 2007.

8.   Equipment on Long-Term Lease

In August 2005, we entered into a ten-year agreement with a customer to provide supply chain services for their fleet of CRJ 700/900 and ERJ 145 regional jets. As part of the agreement, we purchased from the customer approximately $36,500 of equipment to a customersupport the program. The equipment was purchased with an initial cash payment of $22,750, with the remaining balance of approximately $13,750 due in three installments ending in August 2008. The equipment is included in equipment on long-term lease on the consolidated balance sheet and is being depreciated on a short- orstraight-line basis over 10 years to a


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

8.   Equipment on Long-Term Lease (Continued)

30% residual value. The current portion of the deferred payments is included in accounts payable and the long-term basis. Theportion is included in other liabilities and deferred income on the consolidated balance sheet.

In November 2005, we signed a similar supply chain services agreement with this same customer to support their fleet of CRJ 200 regional jets. Under the terms of the operating leases in whichagreement, we are the lessee are one year with options to renew annually at our election. If we elect not to renew a lease or the lease term expires, we will purchase the equipmentpurchased from the lessor at its scheduled purchase option price.customer approximately $21,900 of equipment to support the program. The termsequipment was purchased with an initial cash payment of $16,750, with the lease agreements also allow us to purchase the equipment at any time during a lease at its scheduled purchase option price.remaining balance of approximately $5,150 due in two installments ending in August 2009. The scheduled purchase option values were $30,097deferred payment obligation is included in other liabilities and $33,783 at May 31, 2004 and 2003.



        In those instances in which we anticipate that we will purchase aviation equipment and the scheduled purchase option price will exceed the fair value of such equipment, we record an accrual for loss. The accrual for loss was $5,800 at May 31, 2004 and 2003.

        During the fourth quarter of fiscal 2002, we purchased the equity interest in $31,080 of aviation equipment which we previously accounted for as operating leases. As a result, the amount was recorded as an assetdeferred income on the May 31, 2002 Consolidated Balance Sheet. The lease obligations for these assets, owing to the lessor, converted to a term loan upon the purchase in the amount of $29,737, which was also recorded on the May 31, 2002 Consolidated Balance Sheet. During fiscal 2004, this term loan was retired.consolidated balance sheet.

9.   Commitments and Contingencies

On October 3, 2003, the Companywe entered into a sale-leaseback transaction whereby the Company sold and leased back a facility located in Garden City, New York. The lease is classified as an operating lease in accordance with SFAS No. 13 "Accounting“Accounting for Leases"Leases”. Net proceeds from the sale of the facility were $13,991 and the cost and related accumulated depreciation of the facility of $9,472 and $4,595, respectively, were removed from the consolidated balance sheet. The gain realized of $9,114 on the sale of $9,114 has been deferred and is being amortized over the 20-year lease term in accordance with SFAS No. 13. The unamortized balance of the deferred gain as of May 31, 2007 is $7,533 and is included in the caption "Deferredother liabilities and deferred income and other" on the Consolidated Balance Sheet.consolidated balance sheet.

In June 2004, we signed an agreement to occupy a portion of the Indianapolis Maintenance Center (IMC). In fiscal 2005, we commenced airframe maintenance operations at the IMC and currently occupy seven bays and certain office space, with options to occupy up to three additional bays. Under the terms of the lease, we are entitled to receive rent credits as we increase the number of bays we occupy. During fiscal 2007, 2006 and 2005, we received $700, $1,700 and $350, respectively, of such rent credits and in accordance with SFAS No. 13, we are treating the rent credits as lease incentives, which are being amortized over the term of the lease.

In addition to the aviation equipment operating leases and the Garden City lease,and IMC leases, we lease other facilities and equipment as well as aviation equipment under agreements that are classified as operating leases that expire at various dates through 2023. Future minimum payments under all operating leases at May 31, 20042007 are as follows:

 
 Future Minimum Payments
Year

 Facilities and Equipment
 Aviation Equipment
2005 $5,902 $10,471
2006  5,220  6,783
2007  4,799  14,442
2008  3,915  
2009 and thereafter  30,226  

 

 

Future Minimum Payments

 

Year

 

 

 

Facilities
and Equipment

 

Aviation
Equipment

 

2008

 

 

$

9,426

 

 

 

$

3,840

 

 

2009

 

 

8,385

 

 

 

3,840

 

 

2010

 

 

7,110

 

 

 

1,280

 

 

2011

 

 

5,689

 

 

 

 

 

2012

 

 

5,346

 

 

 

 

 

2013 and thereafter

 

 

25,642

 

 

 

 

 

 


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

9.   Commitments and Contingencies (Continued)

Rental expense during the past three fiscal years was as follows:


 For the Year Ended May 31,

 

For the Year Ended May 31,

 


 2004
 2003
 2002

 

2007

 

2006

 

2005

 

Facilities and Equipment $8,193 $6,597 $7,688

 

$

14,412

 

$

12,514

 

$

9,445

 

Aviation Equipment 3,051 3,117 6,558

 

3,471

 

1,538

 

2,629

 

 

We routinely issue letters of credit and performance bonds in the ordinary course of our business. These instruments are typically issued in conjunction with insurance contracts or other business requirements. The total of these instruments outstanding at May 31, 20042007 was approximately $10,952.$11,891.

We are involved in various claims and legal actions, including environmental matters, arising in the ordinary course of business (see Item 3 Legal Proceedings). In the opinion of management, the ultimate



disposition of these matters will not have a material adverse effect on our consolidated financial condition or results of operations.

10.    Investment   Discontinued Operations

During the third quarter of fiscal 2007, we decided to exit our non-core industrial turbine business based in Leveraged Leases

        Occasionally, we acquire aircraft under leases that qualify for leveraged lease accounting treatment. Typically, these are long-term leases of late-model aircraft operated by major carriers where we are an equity participant of at least 20% and thereFrankfort, New York. The industrial turbine business is a third-party providerunit within the Structures and Systems segment and is expected to be sold within 12 months. Net assets of non-recourse debtthe business were approximately $4,500 at May 31, 2007 and consisted of $1,800 of accounts receivable, $1,200 of inventory, $2,100 of net property, plant and equipment and $600 of accounts payable.

On February 17, 2005, we sold substantially all of the assets, subject to certain liabilities, of our engine component repair business, located in Windsor, Connecticut. The engine component repair business was a unit within the Aviation Supply Chain segment. We received as consideration cash of $7,700 and acquired inventory having a value of approximately $1,200, subject to certain adjustments. As a result of the transaction, we recorded a pre-tax charge of $3,651 ($2,321 after-tax), representing the loss on disposal. Of the $3,651 pre-tax charge, severance charges were $287 and closing costs related to the transaction were $619. The remaining portion of the charge of $2,745 represents the difference between the consideration received and the net book value of the assets sold.

Revenues and pre-tax operating loss for fiscal years 2007, 2006 and 2005 for the remaining equipment cost.discontinued operations are summarized as follows:

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Revenues

 

$

7,778

 

$

11,766

 

$

13,319

 

Pre-tax operating loss

 

$

(1,212

)

$

(1,015

)

$

(2,800

)

11.   Acquisitions

On January 12, 2007, we acquired substantially all the assets of Reebaire, a regional airframe maintenance and repair overhaul facility located in Hot Springs, Arkansas. This acquisition increases our


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

11.   Acquisitions (Continued)

regional MRO capacity in North America. The purchase price was approximately $11,800 and was paid in cash.

Our cost to acquire Reebaire has been preliminarily allocated to the assets acquired based on estimated fair values. The allocation is subject to adjustment when additional information concerning asset valuations is finalized. We have preliminarily allocated the purchase price as follows:

Inventory

 

$

560

 

Equipment

 

660

 

Identifiable intangibles

 

1,580

 

Goodwill

 

9,000

 

We anticipate that the asset valuation will be completed in the first quarter of fiscal 2008.

On April 2, 2007, we acquired Brown, a privately held defense contractor that provides engineering, design, manufacturing and systems integration services. Brown will operate as part of our Structures and Systems segment. The purchase price was approximately $26,700 and was paid in cash.  We have not yet finalized the purchase price allocation for the Brown acquisition and are in the process of obtaining valuations for the acquired net assets.

The results of operations subsequent to the date of the acquisitions are included in the consolidated financial statements. Had the results of the acquisitions been included in the consolidated financial statements for each of the periods presented, the effect would not have been material.

12.   Gain on Sale of Product Line

During the lease termfirst quarter of fiscal 2007, we are required,sold substantially all assets, subject to certain liabilities, of a product line within our Structures and Systems segment. Proceeds from the sale were $6,567 and the net carrying value of the assets sold was $1,209, resulting in a gain on sale of product line of $5,358. The gain on this transaction has been classified as a component of operating income in accordance with SFAS No. 13, "Accounting144, “Accounting for Leases",the Impairment or Disposal of Long-Lived Assets”.

13.   Impairment Charges

During the first quarter of fiscal 2007, we recorded an impairment charge related to adjustcertain engine parts in the elementsamount of $4,750. These parts were acquired prior to September 11, 2001, and were subject to impairment charges recorded in fiscal 2003 and 2002. The fiscal 2007 impairment charge was triggered by our decision to aggressively pursue the investmentliquidation of this inventory. We made this decision to recognize the impairment due to the impact of persistently high fuel costs and fewer operators on demand for these parts, as well as to better align human and physical resources with higher potential opportunities in leveraged leases to reflect changes in important economic assumptions, such as the renegotiationrapidly growing Aviation Supply Chain segment. We had previously recorded impairment charges of $5,360 during the interest rate on the non-recourse debt or changes in income tax rates.

        Duringfourth quarter of fiscal 2003 and $75,900 during the second quarter of fiscal 2004, three of our leveraged leases expired. At that time, we entered into operating leases with a term of two years with the same carrier for each2002 related to engine and airframe parts and whole engines.


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

13.   Impairment Charges (Continued)

A summary of the threecarrying value of impaired inventory and engines, after giving effect to all impairment charges recorded by us in fiscal 2007, 2003 and 2002 is as follows:

 

 

May 31,

 

May 31,

 

May 31,

 

November 30,

 

 

 

2007

 

2006

 

2005

 

2001

 

Net impaired inventory and engines

 

$

27,400

 

$

36,000

 

$

43,200

 

 

$

89,600

 

 

Proceeds from sales of impaired inventory and engines for the twelve-month periods ended May 31, 2007, 2006, and 2005 were $3,800, $7,300 and $7,900, respectively.

Other Impairment and Gain on Extinguishment of Debt

During the first quarter of fiscal 2007, we restructured the lease and non-recourse debt on a wholly-owned wide-body aircraft. This aircraft was originally purchased prior to September 11, 2001. As a result of the remaining asset valuesrestructuring of the lease and debt, we recorded a $2,927 gain on extinguishment of debt. Further, we decided to offer this aircraft for sale and recorded a $2,902 impairment charge to reduce the carrying value of the aircraft were reclassified on the Consolidated Balance Sheet from "Investment in leveraged leases" to "Equipment on long-term lease".

        Ourits estimated net investment in leveraged leases is comprised of the following elements:

 
 May 31,
 
 
 2004
 2003
 
Rentals receivable (net of principal and interest on the non-recourse debt) $5,344 $7,870 
Estimated residual value of leased assets  9,000  25,573 
Unearned and deferred income  (4,803) (6,049)
  
 
 
   9,541  27,394 
Deferred taxes  (7,871) (13,710)
  
 
 
Net investment in leveraged leases $1,670 $13,684 
  
 
 

        Pretax income from leveraged leases was $1,246, $2,743 and $2,523 in fiscal 2004, 2003 and 2002, respectively.

11.    Joint Ventures

        Since fiscal 2002, we have owned a 50% equity interest in a joint venture. The remaining 50% equity interest was owned by a major U.S. financial institution. The joint venture owned one wide-body aircraft on lease to a major foreign carrier and financed the purchase of the aircraft primarily with debt that was without recourse to the joint venture and to the joint venture partners. The joint venture was accounted for under the equity method of accounting.


        In May 2004, the lease with the carrier expired. Although the joint venture was successful in re-leasing the aircraft to a different carrier, we agreed to assign our rights to the aircraft to the non-recourse debt holder. Accordingly, we recorded a $1,269 pre-tax charge in May 2004 representing the write-off of our equity investment in the joint venture.

        The following table provides summarized joint venture financial information at May 31, 2004 and May 31, 2003.

 
 May 31,
 
 2004
 2003
Total assets $ $39,244
Total non-recourse debt    36,028
  
 
Net assets of joint venture $ $3,216
  
 
AAR CORP.'s 50% equity interest in joint venture $ $1,608
  
 

        In June 2004, we entered into an agreement with a global financial institution establishing a limited liability company. Our equity interest in this limited liability company is 50% and the primary business of this venture is the acquisition, ownership, lease and disposition of commercial aircraft.

12.    Other Noncurrent Assets

realizable value. At May 31, 20042007, the carrying value of this aircraft is $26,430 and 2003,is reported in equipment on or available for short term lease on the consolidated balance sheets.

14.   Other Noncurrent Assets

At May 31, 2007 and 2006, other noncurrent assets consisted of the following:


 May 31,

 

May 31,

 


 2004
 2003

 

2007

 

2006

 

Capitalized program development costs

 

$

24,343

 

$

7,459

 

Cash surrender value of life insurance

 

9,729

 

8,444

 

Investment in leveraged lease

 

9,096

 

9,236

 

Notes receivable $13,259 $10,156

 

6,303

 

11,026

 

Investment in aviation equipment 9,123 10,119
Cash surrender value of life insurance 6,146 5,426
Debt issuance costs 4,022 1,491

 

5,327

 

5,956

 

Licenses and rights 3,349 3,973

 

1,871

 

2,357

 

Investment in joint ventures  1,608
Other 21,090 17,330

 

12,985

 

23,577

 

 
 

 

$

69,654

 

$

68,055

 

 $56,989 $50,103
 
 

13.Program Development Costs

In June 2005, we announced that our Cargo Systems business was selected to provide cargo handling systems for the new A400M cargo aircraft. We are teaming with PFW on the program. Our portion of the revenue from this program is expected to exceed $300,000 through fiscal 2015, based on sales projections of the A400M. As of May 31, 2007, we have incurred approximately $24,000 of costs associated with the engineering and development of the cargo system and have capitalized these costs in accordance with SOP 81-1 “Accounting for Performance of Construction—Type and Certain Production—Type Contracts”. Sales and related cost of sales will be recognized on the units of delivery method.

57




AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, exept per share amounts)

15.   Business Segment Information

Segment Reporting

        We are a leading provider of value-added products and services to the global aviation/aerospace industry. We report our activities in four business segments: Inventory and Logistic Services;Aviation Supply Chain; Maintenance, Repair and Overhaul; Manufacturing;Structures and AircraftSystems; and EngineAircraft Sales and Leasing.

Sales in the Inventory and Logistic ServicesAviation 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 to the commercial aviation and



military defense markets, as well as the distributionrepair and overhaul of newa wide range of commercial and military aircraft airframe parts. We also provide customized inventory supply and management programs and performance-based logistics programs for engine and airframe parts purchased from various original equipment manufacturers and sold tocomponents. Sales also include the sale and lease of commercial and general aviation customers.jet engines. Cost of sales consists principally of the cost of product (primarily aircraft and engine parts), direct labor and overhead (primarily indirect labor, facility expensescost and insurance).

Sales in the Maintenance, Repair and Overhaul segment are principally derived from the repair and overhaul of a wide range of commercial and military aircraft engine and airframe parts, landing gear and components, aircraft maintenance and storage and the repair and overhaul and sale of parts for industrial gas and steam turbine operators.most commercial landing gear types. Cost of sales consists principally of the cost of product (primarily replacement aircraft parts), direct labor and overhead.

Sales in the ManufacturingStructures and Systems segment are derived from the manufacture and sale of a wide array of containers, pallets and shelters used to support the U.S. Military'smilitary’s tactical deployment requirements, in-plane cargo loading and handling systems for commercial and military applications and advanced composite materials and componentsproducts for aerospaceaviation and industrial use. Cost of sales consists principally of the cost of product, direct labor and overhead.

Sales in the Aircraft and Engine Sales and Leasing segment are derived from the sale and lease of commercial aircraft and engines and technical and advisory services. Cost of sales consists principally of the cost of product (aircraft and engines)(aircraft), labor and the cost of lease revenue (primarily depreciation, lease expense and insurance).

The accounting policies for the segments are the same as those described in Note 1. Our chief operating decision making officer (Chief Executive Officer) evaluates performance based on the reportable segments.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.

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

 
 For the Year Ended May 31,
 
 2004
 2003
 2002
Net sales:         
 Inventory and Logistic Services $253,958 $246,031 $258,067
 Maintenance, Repair and Overhaul  216,483  205,666  216,727
 Manufacturing  151,310  119,871  99,558
 Aircraft and Engine Sales and Leasing  30,207  34,769  64,369
  
 
 
  $651,958 $606,337 $638,721
  
 
 
          

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Net sales:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

543,674

 

$

461,166

 

$

390,060

 

Maintenance, Repair and Overhaul

 

211,516

 

182,258

 

111,932

 

Structures and Systems

 

264,083

 

228,747

 

193,296

 

Aircraft Sales and Leasing

 

41,896

 

13,347

 

45,139

 

 

 

$

1,061,169

 

$

885,518

 

$

740,427

 



 


 

For the Year Ended May 31,

 
 2004
 2003
 2002
Gross profit, before consideration of impairment charges (see Note 2):         
 Inventory and Logistic Services $41,577 $32,756 $32,135
 Maintenance, Repair and Overhaul  24,980  26,003  32,417
 Manufacturing  29,390  18,775  12,799
 Aircraft and Engine Sales and Leasing  4,760  4,884  12,397
  
 
 
  $100,707 $82,418 $89,748
  
 
 

 


 

May 31,

 
 2004
 2003
 2002
Total assets:         
 Inventory and Logistic Services $162,608 $190,693 $208,515
 Maintenance, Repair and Overhaul  172,114  191,097  190,438
 Manufacturing  86,313  63,044  73,791
 Aircraft and Engine Sales and Leasing  165,098  158,103  146,941
 Corporate  123,159  83,684  90,514
  
 
 
  $709,292 $686,621 $710,199
  
 
 

 


 

For the Year Ended May 31,

 
 2004
 2003
 2002
Capital expenditures:         
 Inventory and Logistic Services $1,394 $572 $627
 Maintenance, Repair and Overhaul  4,557  6,853  8,316
 Manufacturing  3,855  1,764  1,684
 Aircraft and Engine Sales and Leasing  32    2
 Corporate  448  741  1,483
  
 
 
  $10,286 $9,930 $12,112
  
 
 

 


 

For the Year Ended May 31,

 
 2004
 2003
 2002
Depreciation and amortization:         
 Inventory and Logistic Services $2,508 $2,446 $2,646
 Maintenance, Repair and Overhaul  7,306  7,568  7,068
 Manufacturing  3,594  3,468  4,040
 Aircraft and Engine Sales and Leasing  8,756  9,580  4,745
 Corporate  4,516  4,110  3,997
  
 
 
  $26,680 $27,172 $22,496
  
 
 

AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, exept per share amounts)

15.   Business Segment Information (Continued)

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Gross profit:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

114,383

 

$

99,255

 

$

67,672

 

Maintenance, Repair and Overhaul

 

29,915

 

25,914

 

14,414

 

Structures and Systems

 

36,021

 

33,711

 

35,184

 

Aircraft Sales and Leasing

 

3,828

 

4,341

 

3,305

 

 

 

$

184,147

 

$

163,221

 

$

120,575

 

 

 

May 31,

 

 

 

2007

 

2006

 

2005

 

Total assets:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

449,918

 

$

422,519

 

$

298,477

 

Maintenance, Repair and Overhaul

 

124,482

 

91,332

 

86,271

 

Structures and Systems

 

190,386

 

113,189

 

97,780

 

Aircraft Sales and Leasing

 

156,357

 

141,158

 

119,581

 

Corporate

 

146,490

 

210,621

 

130,121

 

 

 

$

1,067,633

 

$

978,819

 

$

732,230

 

 

 

For the��Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Capital expenditures:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

5,376

 

$

5,093

 

$

3,777

 

Maintenance, Repair and Overhaul

 

4,742

 

2,556

 

2,817

 

Structures and Systems

 

18,601

 

6,806

 

5,222

 

Aircraft Sales and Leasing

 

4

 

 

48

 

Corporate

 

1,168

 

1,841

 

1,169

 

 

 

$

29,891

 

$

16,296

 

$

13,033

 

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Depreciation and amortization:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

12,449

 

$

11,849

 

$

10,768

 

Maintenance, Repair and Overhaul

 

2,939

 

2,834

 

2,534

 

Structures and Systems

 

4,939

 

4,929

 

4,481

 

Aircraft Sales and Leasing

 

8,725

 

6,553

 

7,315

 

Corporate

 

3,147

 

3,057

 

4,080

 

 

 

$

32,199

 

$

29,222

 

$

29,178

 


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, exept per share amounts)

15.   Business Segment Information (Continued)

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



 For the Year Ended May 31,
 

 

For the Year Ended May 31,

 



 2004
 2003
 2002
 

 

2007

 

2006

 

2005

 

Segment gross profitSegment gross profit $100,707 $82,418 $89,748 

 

$

184,147

 

$

163,221

 

$

120,575

 

Cost of sales-impairment charges  (5,360) (75,900)
Selling, general and administrative and other (81,929) (78,845) (85,037)
Special charges   (10,100)
Interest expense (18,819) (19,539) (19,798)
Interest income 1,748 1,836 2,858 
 
 
 
 
Income (loss) before provision for income taxes $1,707 $(19,490)$(98,229)
 
 
 
 

Selling, general and administrative and other

 

(105,091

)

(99,551

)

(86,226

)

Earnings from aircraft joint ventures

 

10,952

 

1,502

 

568

 

Gain on sale of product line

 

5,358

 

 

 

Gain (loss) on extinguishment of debt

 

2,927

 

(3,893

)

3,562

 

Interest expense

 

(16,701

)

(18,004

)

(16,917

)

Interest income and other

 

5,829

 

3,236

 

1,502

 

Income before provision for income taxes

 

$

87,421

 

$

46,511

 

$

23,064

 

 

No single non-government customer represents 10% or more of total sales in any of the last three fiscal years. Sales to the U.S. Government, its agenciesDepartment of Defense and its contractors by segment are as follows:

 
 For the Year Ended May 31,
 
 
 2004
 2003
 2002
 
Inventory and Logistic Services $60,468 $40,925 $28,489 
Maintenance, Repair and Overhaul  37,031  44,163  65,832 
Manufacturing  125,059  85,103  66,992 
Aircraft and Engine Sales and Leasing      1,860 
  
 
 
 
  $222,558 $170,191 $163,173 
  
 
 
 
Percentage of total sales  34.1% 28.1% 25.5%
  
 
 
 

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Aviation Supply Chain

 

$

75,185

 

$

77,340

 

$

69,027

 

Maintenance, Repair and Overhaul

 

32,184

 

31,089

 

25,976

 

Structures and Systems

 

217,911

 

185,349

 

154,213

 

 

 

$

325,280

 

$

293,778

 

$

249,216

 

Percentage of total sales

 

30.7

%

33.2

%

33.7

%

Geographic Data

 
 May 31,
 
 2004
 2003
Long-lived assets:      
 United States $264,987 $278,551
 Europe  11,932  11,480
 Other  169  178
  
 
  $277,088 $290,209
  
 

 

 

May 31,

 

 

 

2007

 

2006

 

Long-lived assets:

 

 

 

 

 

United States

 

$

410,285

 

$

343,121

 

Europe

 

11,440

 

11,090

 

Other

 

187

 

154

 

 

 

$

421,912

 

$

354,365

 

 

Export sales from our U.S. operations to unaffiliated customers, the majority of which are located in Europe, the Middle East, Canada, Mexico, South America and Asia (including sales through foreign sales offices of domestic subsidiaries), were approximately $111,902 (17.2%$220,974 (20.8% of total sales), $142,403 (23.5%$180,752 (20.4% of total sales) and $134,809 (21.1%$178,025 (24.0% of total sales) in fiscal 2004, 20032007, 2006 and 2002,2005, respectively.


AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, exept per share amounts)

14.16.   Selected Quarterly Data (Unaudited)

The unaudited selected quarterly data for fiscal years ended May 31, 20042007 and 20032006 follows.


 Fiscal 2004
  
  
 
Quarter

 Net Income (Loss)
 Diluted Earnings (Loss) Per Share
 

Fiscal 2007

 

Quarter

Sales
 Gross Profit
 Net Income (Loss)
 Diluted Earnings (Loss) Per Share
 

 

 

 

Sales

 

Gross Profit

 

Net Income
from
Continuing
Operations

 

Diluted Earnings
Per Share-
Continuing
Operations

 

 $152,114 $21,116)

First

 

$

240,242

 

 

$

35,371

 

 

 

$

12,229

 

 

 

$

0.30

 

 

Second 159,519 25,130 916 0.03 

Second

 

244,272

 

 

45,903

 

 

 

13,982

 

 

 

0.34

 

 

Third 161,151 26,573 2,012 0.06 

Third

 

270,978

 

 

47,275

 

 

 

15,519

 

 

 

0.37

 

 

Fourth 179,174 27,888 2,572 0.08 

Fourth

 

305,677

 

 

55,598

 

 

 

17,717

 

 

 

0.42

 

 

 
 
 
 
 

 

$

1,061,169

 

 

$

184,147

 

 

 

$

59,447

 

 

 

$

1.42

 

 

 $651,958 $100,707 $3,504 $0.11 
 
 
 
 
 



 

Fiscal 2003


 

 


 

 


 
Quarter

 Net Income (Loss)
 Diluted Earnings (Loss) Per Share
 
Sales
 Gross Profit
 
First $151,165 $17,765 $(4,879)$(0.15)
Second 153,051 22,930 (663) (0.02)
Third 156,992 24,525 651 0.02 
Fourth 145,129 11,838 (7,519) (0.24)
 
 
 
 
 
 $606,337 $77,058 $(12,410)$(0.39)
 
 
 
 
 

 See Note 2 for a description of impairment charges recorded during the fourth quarter of fiscal 2003.

Fiscal 2006

 

Quarter

 

 

 

Sales

 

Gross Profit

 

Net Income
from
Continuing
Operations

 

Diluted Earnings
Per Share-
Continuing
Operations

 

First

 

$

197,073

 

 

$

34,418

 

 

 

$

5,335

 

 

 

$

0.15

 

 

Second

 

215,394

 

 

37,621

 

 

 

7,944

 

 

 

0.22

 

 

Third

 

223,398

 

 

43,106

 

 

 

9,195

 

 

 

0.24

 

 

Fourth

 

249,653

 

 

48,076

 

 

 

13,349

 

 

 

0.32

 

 

 

 

$

885,518

 

 

$

163,221

 

 

 

$

35,823

 

 

 

$

0.96

 

 

15.17.   Allowance for Doubtful Accounts



 May 31,
 

 

May 31,

 



 2004
 2003
 2002
 

 

2007

 

2006

 

2005

 

Balance, beginning of yearBalance, beginning of year $8,663 $10,624 $11,016 

 

$

6,466

 

$

5,863

 

$

6,310

 

Provision charged to operations 2,771 3,140 2,697 
Special charge (see Note 2)   5,700 
Deductions for accounts written off, net of recoveries (5,124) (5,101) (8,789)
 
 
 
 

Provision charged to operations

 

1,500

 

2,580

 

2,391

 

Deductions for accounts written off, net of recoveries

 

(4,081

)

(1,977

)

(2,838

)

Balance, end of yearBalance, end of year $6,310 $8,663 $10,624 

 

$

3,885

 

$

6,466

 

$

5,863

 

 
 
 
 

61





ITEM 9.                CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

        Not applicable.None.


ITEM 9A.        CONTROLS AND PROCEDURES

As required by Rules 13a-15(e) and 15d-15(e) of the Act, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of May 31, 2004,2007. This evaluation was carried out under the supervision and with participation of our Chief Executive Officer and Chief Financial Officer. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures. Therefore, effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon our evaluation, our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures and concluded that our disclosure controls and procedures effectively ensureare effective as of May 31, 2007, ensuring that information required to be disclosed in the reports that are filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported in a timely manner.

There were no changes toin our internal control over financial reporting during our last fiscal quarterthe three-month period ended May 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The Company’s Common Stock is listed on the New York Stock Exchange (“NYSE”) under the ticker symbol “AIR”. On October 27, 2006, our Chief Executive Officer certified to the NYSE pursuant to Rule 303A.12(a) that, as of the date of that certification, he was not aware of any violation by the Company of the NYSE’s Corporate Governance listings standards.

MANAGEMENT REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of AAR CORP. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles. Internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems which are determined to be effective provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of its internal control over financial reporting based on criteria for effective internal control over financial reporting described in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

Based on our assessment, management concluded that the Company maintained effective internal control over financial reporting as of May 31, 2007. Our assessment of the effectiveness of our internal control over financial reporting as of May 31, 2007, has been audited by KPMG LLP, an independent registered public accounting firm, as stated in its report which is included herein.

The scope of management’s assessment of the effectiveness of internal control over financial reporting includes all of our Company’s consolidated subsidiaries except for Brown International Corporation (“Brown”), a business acquired by our Company on April 2, 2007. Our Company’s consolidated net sales for the year-ended May 31, 2007 were $1,061,169 of which Brown represented  $12,368. Our Company’s consolidated total assets as of May 31, 2007 were $1,067,633, of which Brown represented $33,043.


Report of Independent Registered Public Accounting Firm

TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF AAR CORP.:

We have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, that AAR CORP. and subsidiaries (the Company) maintained effective internal control over financial reporting as of May 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of May 31, 2007, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by COSO. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of May 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by COSO.

The scope of management’s assessment of the effectiveness of internal control over financial reporting as of May 31, 2007 includes all of the Company’s consolidated subsidiaries except for Brown International Corporation (Brown), a business acquired by the Company on April 2, 2007. The Company’s consolidated net sales for the year-ended May 31, 2007 were $1,061,169, of which Brown represented $12,368. The Company’s consolidated total assets as of May 31, 2007 were $1,067,633 of which Brown represented $33,043. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over the financial reporting of Brown.


We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of May 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the three-year period ended May 31, 2007, and our report dated July 19, 2007 expressed an unqualified opinion on those consolidated financial statements.

KPMG LLP

Chicago, Illinois

July 19, 2007

ITEM 9B.       OTHER INFORMATION

None

64




PART III

ITEM 10.         DIRECTORS, AND EXECUTIVE OFFICERS OF THE REGISTRANT
AND CORPORATE GOVERNANCE

The information required by this item regarding the Directors of the Company and nominees for election of the Board is incorporated by reference to the information contained under the caption "Board“Board of Directors"Directors” in our definitive proxy statement for the 20042007 Annual Meeting of Stockholders.

The information required by this item regarding the Executive Officers of the Company appears under the caption "Executive“Executive Officers of the Registrant"Registrant” in Part I, Item 4 above.

The information required by this item regarding the compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference to the information contained under the caption "Section“Section 16(a) Beneficial Ownership Reporting Compliance"Compliance” in our definitive proxy statement for the 20042007 Annual Meeting of Stockholders.

        InformationThe information required by this item regarding the identification of the Audit Committee as a separately-designated standing committee of the Board is set forthincorporated by reference to the information contained under the caption “Board Committees” in our definitive proxy statement infor the section entitled "Board Committees,"2007 Annual Meeting of Stockholders, and information required by this item regarding the status of one or more members of the Audit Committee being an "audit“audit committee financial expert"expert” is set forthincorporated by reference to the information contained under the caption “Board Committees” in our definitive proxy statement infor the section entitled "Board Committees," which2007 Annual Meeting of Stockholders.

The information is incorporated hereinrequired by reference.

        Informationthis item regarding our Code of Business Ethics and Conduct applicable to our directors, officers and employees is incorporated by reference to the information contained under the caption "Corporate“Corporate Governance Information"Information” in our definitive proxy statement for the 20042007 Annual Meeting of Stockholders.

There have been no material changes to the procedures by which stockholders may recommend nominees to the Company’s board of directors. For a description of those procedures, see the caption “Board of Directors” in our definitive proxy statement for the 2007 Annual Meeting of Stockholders.


ITEM 11.         EXECUTIVE COMPENSATION

 

The information required by this item is incorporated by reference to the information contained under the captions "Executive“Executive Compensation and Other Information" (but excluding the following sections thereof: "Compensation Committee's Report on Executive Compensation" and "Stockholder Return Performance Graph"); "EmploymentInformation”, “Compensation Committee Report”, “Employment and Other Agreements"Agreements” and "Directors' Compensation"“Directors’ Compensation” in our definitive proxy statement for the 20042007 Annual Meeting of Stockholders.


ITEM 12.         SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS

 

The numberinformation required by this item regarding security ownership of shares (in thousands)certain beneficial owners and management is incorporated by reference to be issued upon exercisethe information contained under the caption “Security Ownership of Management and Others” in our definitive proxy statement for the number2007 Annual Meeting of shares remaining available for future issuance under our equityStockholders.


The following table provides information as of May 31, 2007 with respect to the Company’s compensation plans at May 31, 2004 were as follows:under which equity securities of the Company are authorized for issuance:


 Equity Compensation Plan Information

 

Equity Compensation Plan Information

 


 Number of securities to be
issued upon exercise of
outstanding options, warrants and rights
(a)

 Weighted-average
exercise price of
outstanding options,
warrants and rights
(b)

 Number of securities remaining available for future issuance under equity compensation
plans (excluding securities
reflected in column (a))
(c)

 

Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
(a)

 

Weighted-average
exercise price of
outstanding options,
warrants and rights
(b)

 

Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
(c)

 

Equity compensation plans approved by security holders 5,154 $14.35 1,719

 

 

2,135

 

 

 

$

18.30

 

 

 

3,368

 

 


Equity compensation plans not approved by security holders

 


 


 

 

 

 

 

 

 

 

 

 

 

 
 
 

Total

 

5,154

 

$14.35

 

1,719

 

 

2,135

 

 

 

$

18.30

 

 

 

3,368

 

 

 
 
 

ITEM 13.         CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

The information required by this item is incorporated by reference to the information contained under the caption "Security Ownershipcaptions “Board of ManagementDirectors—Director Independence”“ and Others"“Corporate Governance Information—Related Party Transactions” in our definitive proxy statement for the 20042007 Annual Meeting of Stockholders.


ITEM 13.    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        The information required by this item is incorporated by reference to the information contained under the caption "Certain Relationships and Related Transactions" in our definitive proxy statement for the 2004 Annual Meeting of Stockholders.


ITEM 14.         PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

The information required by this item is incorporated by reference to the information contained under the caption "Principal Accountant“Independent Registered Public Accounting Firm Fees and Services"Services” in our definitive proxy statement for the 20042007 Annual Meeting of Stockholders.

66





PART IV


PART IV

ITEM 15.         EXHIBITS AND FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)(1) and (2) Financial Statements and Financial Statement Disclosures

The following financial statements are filed as a part of this report under “Item 8—Financial Statements and Supplementary Data”


Page


Report of Independent Registered Public Accounting Firm

19

26

Financial Statements—AAR CORP. and Subsidiaries:

Consolidated Statements of Operations for the three years ended May 31, 20042007

21

27

Consolidated Balance Sheets as of May 31, 20042007 and 20032006

22-23

28-29

Consolidated Statements of Stockholders'Stockholders’ Equity for the three years ended May 31, 20042007

24

30

Consolidated Statements of Cash Flows for the three years ended May 31, 20042007

25

31

Notes to Consolidated Financial Statements

26-53

32-61

Selected quarterly data (unaudited) for the years ended May 31, 20042007 and 20032006 (Note 1416 of Notes to Consolidated Financial Statements)

53

61

Exhibits

(a)(3) Exhibits

The Exhibits filed as part of this report are set forth in the Exhibit Index contained elsewhere herein. Management contracts and compensatory arrangements have been marked with an asterisk (*) on the Exhibit Index.

67




Reports on Form 8-K

        On March 17, 2004, we filed a current report on Form 8-K reporting under Item 12 that we had issued a press release announcing financial results for the third fiscal quarter ended February 29, 2004.

        On April 12, 2004, we filed a current report on Form 8-K reporting under Item 12 that we had issued a press release announcing that in conjunction with the filing of our Form 10-Q for the quarter ended February 29, 2004, we recorded an additional expense resulting from an unfavorable Court ruling relating to an engine lease transaction.


SIGNATURES


SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this annual report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

AAR CORP.
(Registrant)


Date: July 21, 200420, 2007






By:

BY:



/s/ DAVID P. STORCH


David P. Storch

PresidentChairman and Chief Executive Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this annual report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Signature


Title



Date








/s/ IRA A. EICHNER      David


Ira A. Eichner
Chairman of the Board
Director
July 21, 2004

/s/  
DAVID P. STORCH      
David P. Storch



PresidentChairman and Chief Executive Officer; Director (Principal Executive Officer)



July 20, 2007


July 21, 2004


David
 P. Storch

/s/ TIMOTHY J. ROMENESKO      


Timothy J. Romenesko



Vice President and Chief Operating Officer; Director

Timothy J. Romenesko

/s/ Richard J. Poulton

Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer)




July 21, 2004


Richard J. Poulton

/s/ MICHAEL J. SHARP      


Michael J. Sharp



Vice President and Controller
(Principal (Principal Accounting Officer)




July 21, 2004


/s/  
A. ROBERT ABBOUD      
A. Robert Abboud

Michael J. Sharp



Director



July 21, 2004


/s/ Michael R. Boyce

DirectorJAMES G. BROCKSMITH, JR.      


Michael R. Boyce

/s/ James G. Brocksmith, Jr.



Director




July 21, 2004


James G. Brocksmith, Jr.

/s/ Gerald F. Fitzgerald, Jr.

DirectorRONALD R. FOGLEMAN      


Gerald F. Fitzgerald, Jr.

/s/ Ronald R. Fogleman



Director




July 21, 2004


Ronald R. Fogleman

/s/ JAMES E. GOODWIN      


James E. Goodwin



Director




July 21, 2004


/s/  
JOEL D. SPUNGIN      
Joel D. Spungin

James E. Goodwin



Director



July 21, 2004


/s/ MARCPatrick J. WALFISH      Kelly

Director


Patrick J. Kelly

/s/ Marc J. Walfish



Director




July 21, 2004


EXHIBIT INDEX

 
 Index
  
 Exhibits

 

 

 

 

 

 

 
3. Articles of Incorporation and By-Laws 3.1 Restated Certificate of Incorporation; Amendments thereto dated November 3, 1987, October 19, 1988, October 16, 1989 and November 3, 1999 (filed herewith).

 

 

 

 

3.2

 

By-Laws as amended. Amendment thereto dated April 12, 1994, January 13, 1997, July 16, 1992, April 11, 2000 and May 13, 2002 (filed herewith).

4.

 

Instruments defining the rights of security holders

 

4.1

 

Restated Certificate of Incorporation and Amendments (see Exhibit 3.1).

 

 

 

 

4.2

 

By-Laws as amended (See Exhibit 3.2).

 

 

 

 

4.3

 

Rights Agreement between the Registrant and the First National Bank of Chicago dated July 8, 199710 and amended October 16, 2001.15

 

 

 

 

4.4

 

Indenture dated October 15, 1989 between the Registrant and U.S. Bank Trust National Association (formerly known as First Trust, National Association, as successor in interest to Continental Bank, National Association) as Trustee, relating to debt securities;3 First Supplemental Indenture thereto dated August 26, 1991;4 Second Supplemental Indenture thereto dated December 10, 1997.11

 

 

 

 

4.5

 

Officers' certificates relating to debt securities dated October 24, 1989,7 October 12, 1993,7 December 15, 199719 and May 31, 2002.19

 

 

 

 

4.6

 

Revolving Loan Agreement dated April 11, 2001 between Registrant and LaSalle Bank National Association16 amended November 30, 2001,17 April 22, 2002,17 June 6, 2002,17 March 10, 2003,18 March 21, 2003,18 May 9, 2003,19 June 26, 200319 and March 2, 2004 (filed herewith).

 

 

 

 

4.7

 

Note Purchase Agreement dated May 1, 2001 between Registrant and various purchasers, relating to the issuance of debt securities to institutional investors.16

 

 

 

 

4.8

 

Credit Agreement dated May 29, 2003 between Registrant and various subsidiaries and Merrill Lynch Capital and various additional lenders from time to time who are parties thereto,19 as amended January 23, 2004 (filed herewith).

 

 

 

 

4.9

 

Loan and Security Agreement dated July 1, 2003 between Registrant's subsidiary, AAR Wood Dale LLC and Fremont Investment Loan.19

 

 

 

 

4.10

 

Form of 2.875% Senior Convertible Note.22

 

 

 

 

4.11

 

Indenture between AAR CORP. as Issuer and U.S. Bank National Association, as Trustee dated February 3, 2004.22
       






4.12


Registration Rights Agreement between AAR CORP. and Goldman, Sachs & Co., as representative of the several Purchasers, dated February 3, 2004.22

Marc J. Walfish







Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant is not filing certain documents. The Registrant agrees to furnish a copy of each such document upon the request of the Commission.


10.

/s/ Ronald B. Woodard



Material Contracts

Director



10.1*


Amended and Restated AAR CORP. Stock Benefit Plan effective October 1, 2001,15 as amended June 27, 2003.19


Ronald B. Woodard





10.2*


Death Benefit Agreement dated August 24, 1984 between the Registrant and Ira A. Eichner.5 Amendments thereto dated August 12, 1988,2 May 25, 199012 and October 9, 1996,12 and his agreement to terminate such Death Benefit Agreement dated May 30, 1999.12





10.3*


Further Restated and Amended Employment Agreement dated August 1, 1985 between the Registrant and Ira A. Eichner.1 Amendments thereto dated August 12, 1988,2 May 25, 1990,9 July 13, 1994,9 October 9, 199612 and May 31, 1999.12





10.4*


Trust Agreement dated August 12, 1988 between the Registrant and Ira A. Eichner2 and amendments thereto dated May 25, 1990,9 February 4, 1994,8 October 9, 199612 and May 31, 1999.12





10.5*


AAR CORP. Directors' Retirement Plan, dated April 14, 1992,6 amended May 26, 200013 and April 10, 2001.16





10.6*


AAR CORP. Amended and Restated Supplemental Key Employee Retirement Plan, dated May 4, 2000,13 amended April 10, 2001,16 October 10, 2001,17 October 10, 2002,18 December 18, 200218 and July 1, 2003.20





10.7*


Amended and Restated Employment Agreement dated July 14, 1998 between the Registrant and David P. Storch13 and amended July 10, 2001.14





10.8*


Amended and Restated Severance and Change in Control Agreement dated April 11, 2000 between the Registrant and Howard A. Pulsifer.13





10.9*


Amended and Restated Severance and Change in Control Agreement dated August 1, 2000 between the Registrant and Michael J. Sharp.16





10.10*


Amended and Restated Severance and Change in Control Agreement dated April 11, 2000 between the Registrant and Timothy J. Romenesko.13





10.11*


Amended and Restated AAR CORP. Nonemployee Directors' Deferred Compensation Plan, dated April 8, 1997, amended May 26, 2000,13 December 18, 200218 and July 1, 2003.20

68




EXHIBIT INDEX


 

 

 

 

10.12*

 

Severance and Change in Control Agreement dated January 14, 2000 between the Registrant and James J. Clark.18

 

 

 

 

10.13

 

Purchase and Sale Agreement dated March 21, 2003 between AAR Distribution, Inc., AAR Parts Trading, Inc., AAR Manufacturing, Inc., AAR Engine Services, Inc., AAR Allen Services, Inc., the Registrant as Initial Servicer and AAR Receivables Corporation II.18

 

 

 

 

10.14

 

Receivables Purchase Agreement dated March 21, 2003 between AAR Receivables Corporation II, the Registrant individually and as Initial Servicer, the Financial Institutions from time to time Parties hereto and LaSalle Business Credit, LLC,18 amended November 30, 2003 and February 27, 2004 (filed herewith).

 

 

 

 

10.15

 

Indenture dated October 3, 2003 between AAR Distribution, Inc. and iStar Garden City LLC.21

 

 

 

 

10.16

 

Lease Agreement dated October 3, 2003 between AAR Allen Services, Inc., as tenant and iStar Garden City LLC, as Landlord, and related Guaranty dated October 3, 2003 from Registrant to iStar Garden City LLC.21

 

 

 

 

10.17*

 

Consulting Agreement dated June 1, 1999 between the Registrant and Ira A. Eichner amended June 1, 2003.23

 

 

 

 

10.18*

 

Severance and Change in Control Agreement dated April 1, 2003 between AAR Manufacturing, Inc. and Mark McDonald.23

21.

 

Subsidiaries of the Registrant

 

21.1

 

Subsidiaries of AAR CORP. (filed herewith).

23.

 

Consents of experts and counsel

 

23.1

 

Consent of Independent Registered Public Accounting Firm (filed herewith).

31.

 

Rule 13a-14(a)/15(d)-14(a)
Certifications

 

31.1

 

Section 302 Certification dated July 21, 2004 of David P. Storch, President and Chief Executive Officer of Registrant (filed herewith).

 

 

 

 

31.2

 

Section 302 Certification dated July 21, 2004 of Timothy J. Romenesko, Vice President and Chief Financial Officer of Registrant (filed herewith).

32.

 

Rule 13a-14(b)/15d-14(b)
Certifications

 

32.1

 

Section 906 Certification dated July 21, 2004 of David P. Storch, President and Chief Executive Officer of Registrant (filed herewith).

 

 

 

 

32.2

 

Section 906 Certification dated July 21, 2004 of Timothy J. Romenesko, Vice President and Chief Financial Officer of Registrant (filed herewith).

 

Index

 

 

 

Exhibits

 

3.

 

Articles of Incorporation and By-Laws

 

3

.1

Restated Certificate of Incorporation; Amendments thereto dated November 3, 1987, October 19, 1988, October 16, 1989 and November 3, 1999.20

 

 

 

 

 

3

.2

By-Laws as amended (filed herewith).

 

4.

 

Instruments defining the rights of security holders

 

4

.1

Restated Certificate of Incorporation and Amendments (see Exhibit 3.1).

 

 

 

 

 

4

.2

By-Laws as amended (See Exhibit 3.2).

 

 

 

 

 

4

.3

Rights Agreement between the Registrant and the First National Bank of Chicago dated July 8, 19979 and amended October 16, 2001.14

 

 

 

 

 

4

.4

Indenture dated October 15, 1989 between the Registrant and U.S. Bank Trust National Association (formerly known as First Trust, National Association, as successor in interest to Continental Bank, National Association) as Trustee, relating to debt securities;3 First Supplemental Indenture thereto dated August 26, 1991;4 Second Supplemental Indenture thereto dated December 10, 1997.10

 

 

 

 

 

4

.5

Officers’ certificates relating to debt securities dated October 24, 1989,6 October 12, 1993,December 15, 1997,16 and May 30, 2003.16

 

 

 

 

 

4

.6

Note Purchase Agreement dated May 1, 2001 between Registrant and various purchasers, relating to the issuance of debt securities to institutional investors.13

 

 

 

 

 

4

.7

Form of 2.875% Senior Convertible Note.18

 

 

 

 

 

4

.8

Indenture between AAR CORP. as Issuer and U.S. Bank National Association, as Trustee dated February 3, 2004.18

 

 

 

 

 

4

.9

Registration Rights Agreement between AAR CORP. and Goldman, Sachs & Co., as representative of the several Purchasers, dated February 3, 2004. 18

 

 

 

 

 

4

.10

Loan Agreement dated July 15, 2005 between Registrant’s Subsidiary, AAR Wood Dale LLC and Principal Commercial Funding, LLC.22

 

 

 

 

 

4

.11

Purchase Agreement between AAR CORP. and Merrill Lynch & Co., for itself and as representative of the other Initial Purchasers, dated January 26, 2006. 26

 

 

 

 

 

4

.12

Form of 1.75% Senior Convertible Note.27

 

 

 

 

 

4

.13

Indenture between AAR CORP. and U.S. Bank, National Association, as trustee, dated February 1, 2006.27

 

 

 

 

 

4

.14

Registration Rights Agreement between AAR CORP. and Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated, as representative of the initial purchasers, dated February 1, 2006.27

 




 

 

 

4

.15

Credit Agreement dated August 31, 2006 among AAR CORP., LaSalle Bank National Association, as administrative agent, and the various financial institutions party thereto.31

 

 

 

 

 

4

.16

Rights Agreement between the Registrant and Computershare Trust Company, N.A. dated July 11, 2007.33

 

 

 

 

 

 

 

Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant is not filing certain documents. The Registrant agrees to furnish a copy of each such document upon the request of the Commission.

 

10.

 

Material Contracts

 

10

.1*

Amended and Restated AAR CORP. Stock Benefit Plan effective October 1, 2001,14 as amended June 27, 2003,16 May 5, 2005,21 July 12, 2005,28 June 23, 2006 (filed herewith) and January 23, 2007 (filed herewith).

 

 

 

 

 

10

.2*

Death Benefit Agreement dated August 24, 1984 between the Registrant and Ira A. Eichner.1 Amendments thereto dated August 12, 1988,2 May 25, 199011 and October 9, 1996,11 and his agreement to terminate such Death Benefit Agreement dated May 30, 1999.11

 

 

 

 

 

10

.3*

Trust Agreement dated August 12, 1988 between the Registrant and Ira A. Eichner2 and amendments thereto dated May 25, 1990,8 February 4, 1994,7 October 9, 199611 and May 30, 1999.11

 

 

 

 

 

10

.4*

AAR CORP. Directors’ Retirement Plan, dated April 14, 1992,5 amended May 26, 200012 and April 10, 2001.13

 

 

 

 

 

10

.5*

AAR CORP. Supplemental Key Employee Retirement Plan, as Amended and Restated effective January 1, 2005,30 as amended July 11, 2007 (filed herewith).

 

 

 

 

 

10

.6*

Amended and Restated Employment Agreement dated May 31, 2006 between the Registrant and David P. Storch.29

 

 

 

 

 

10

.7*

Amended and Restated Severance and Change in Control Agreement dated April 11, 2000 between the Registrant and Howard A. Pulsifer.12

 

 

 

 

 

10

.8*

Amended and Restated Severance and Change in Control Agreement dated August 1, 2000 between the Registrant and Michael J. Sharp.13

 

 

 

 

 

10

.9*

Amended and Restated Severance and Change in Control Agreement dated April 11, 2000 between the Registrant and Timothy J. Romenesko.12

 

 

 

 

 

10

.10*

AAR CORP. Nonemployee Directors’ Deferred Compensation Plan, as Amended and Restated effective January 1, 2005.32

 

 

 

 

 

10

.11*

Severance and Change in Control Agreement dated January 14, 2000 between the Registrant and James J. Clark.15

 




 

 

 

10

.12

Indenture dated October 3, 2003 between AAR Distribution, Inc. and iStar Garden City LLC.17

 

 

 

 

 

10

.13

Lease Agreement dated October 3, 2003 between AAR Allen Services, Inc., as tenant and iStar Garden City LLC, as Landlord, and related Guaranty dated October 3, 2003 from Registrant to iStar Garden City LLC.17

 

 

 

 

 

10

.14*

Consulting Agreement dated October 19, 2005 between the Registrant and Ira A. Eichner.24

 

 

 

 

 

10

.15*

Severance and Change in Control Agreement dated April 1, 2003 between AAR Manufacturing, Inc. and Mark McDonald.19

 

 

 

 

 

10

.16

Lease Agreement by and between Indianapolis Airport Authority and AAR Aircraft Services, Inc. dated as of June 14, 2004, as amended January 21, 200521 and May 19, 2006.32

 

 

 

 

 

10

.17*

Form of Non-Qualified Stock Option Agreement.21

 

 

 

 

 

10

.18*

Form of Restricted Stock Agreement.21

 

 

 

 

 

10

.19*

Form of Performance Restricted Stock Agreement.23

 

 

 

 

 

10

.20*

Form of Non-Employee Director Non-Qualified Stock Option Agreement.25

 

 

 

 

 

10

.21*

Form of Director Restricted Stock Agreement.28

 

 

 

 

 

10

.22*

Form of Split Dollar Insurance Agreement.32

 

 

 

 

 

10

.23*

Form of Management Incentive Plan.32

 

21.

 

Subsidiaries of the Registrant

 

21

.1

Subsidiaries of AAR CORP. (filed herewith).

 

23.

 

Consents of experts and counsel

 

23

.1

Consent of Independent Registered Public Accounting Firm (filed herewith).

 

31.

 

Rule 13a-14(a)/15(d)-14(a) Certifications

 

31

.1

Section 302 Certification dated July 20, 2007 of David P. Storch, Chief Executive Officer of Registrant (filed herewith).

 

 

 

 

 

31

.2

Section 302 Certification dated July 20, 2007 of Richard J. Poulton, Vice President and Chief Financial Officer of Registrant (filed herewith).

 

32.

 

Rule 13a-14(b)/15d-14(b) Certifications

 

32

.1

Section 906 Certification dated July 20, 2007 of David P. Storch, Chief Executive Officer of Registrant (filed herewith).

 

 

 

 

 

32

.2

Section 906 Certification dated July 20, 2007 of Richard J. Poulton, Vice President and Chief Financial Officer of Registrant (filed herewith).

 


Notes:

    1

    Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 1986.
1985.




      2
      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 1988.

      3

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Quarterly Report on Form 10-Q for the quarter ended November 30, 1989.

      4

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Registration Statement on Form S-3 filed August 27, 1991.

      5

      Incorporated by reference to Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1985.

      6
      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 1992.

      76         

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Current Reports on Form 8-K dated October 24, 1989 and October 12, 1993, respectively.

      87         

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 1994.

      98         

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 1996.

      109         

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Current Report on Form 8-K dated August 4, 1997.

      1110        

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Registration Statement on Form S-3 filed December 10, 1997.

      1211        

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 1999.

      1312        

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 2000.

      1413        

      Incorporated by reference to Exhibits to the Registrant's Quarterly Report on Form 10-Q for the quarter ended August 31, 2001.

      15
      Incorporated by reference to Exhibits to the Registrant's Quarterly Report on Form 10-Q for the quarter ended November 30, 2001.

      16
      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 2001.

      1714        

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Quarterly Report on Form 10-Q for the quarter ended November 30, 2001.

      15         Incorporated by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended February 28, 2003.

      16         Incorporated by reference to Exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 2002.

      2003.

      1817        

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Quarterly Report on Form 10-Q for the quarter ended November 30, 2003.

      18         Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated February 3, 2004.

      19         Incorporated by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended February 28, 2003.

      29, 2004.

      1920        

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 2003.

      2004.

      2021        

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 2005.

      22         Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated July 15, 2005.




      23         Incorporated by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended August 31, 2003.

      2005.

      2124        

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Current Report on Form 8-K dated October 24, 2005.

      25         Incorporated by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended November 30, 2003.

      2005.

      2226        

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Current Report on Form 8-K dated January 26, 2006.

      27         Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated February 3, 2004.

      1, 2006.

      2328        

      Incorporated by reference to Exhibits to the Registrant'sRegistrant’s Quarterly Report on Form 10-Q for the quarter ended February 28, 2006.

      29         2004.

    Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated May 31, 2006.

    30         Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated June 9, 2006.

    31         Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated September 5, 2006.

    32         Incorporated by reference to Exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 2006.

    33                 Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated July 12, 2007.





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      TABLE OF CONTENTS
      PART I
      PART II
      PART III
      PART IV
      SIGNATURES
      EXHIBIT INDEX