UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-K

(Mark One)

x

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

For the fiscal year ended May 31, 20052007

or

o

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

For the transition period from            to           

Commission file 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.)

One AAR Place, 1100 N. Wood Dale Road, Wood Dale, Illinois 60191incorporation or organization)

(Address of principal executive offices, including zip code)

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

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

 

 

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

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

 

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
x 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.  Yes x No o

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.  o

Indicate by check mark whether the registrant 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 Registrantregistrant is an accelerated filera shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
xo No ox

At November 30, 2004,2006, the aggregate market value of the Registrant’sregistrant’s voting stock held by nonaffiliates was approximately $430,884,264$955,063,050 (based upon the closing price of the Common Stock at November 30, 20042006 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 18, 2005,June 30, 2007, there were 32,591,47837,795,630 shares of Common Stock outstanding.

Documents Incorporated by Reference

Portions of the definitive proxy statement relating to the Registrant’s 2005registrant’s 2007 Annual Meeting of Stockholders, to be held October 19, 200517, 2007 are incorporated by reference in Part III to the extent described therein.III.

 




TABLE OF CONTENTS

 

 

 

Page

PART I

 

 

 

 

Item 1.

 

Business

 

2

Item 1A.

Risk Factors

5

Item 1B.

Unresolved Staff Comments

10

Item 2.

 

Properties

 

6

10

Item 3.

 

Legal Proceedings

 

6

10

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

7

11

 

 

Supplemental Item—Executive Officers of the Registrant

 

8

12

PART II

 

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

9

13

Item 6.

 

Selected Financial Data

 

10

14

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

12

15

Item 7A.

 

Quantitative and Qualitative Disclosures about Market Risk

 

19

25

Item 8.

 

Financial Statements and Supplementary Data

 

20

26

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

56

62

Item 9A.

 

Controls and Procedures

 

56

62

Item 9B.

 

Other Information

 

58

64

PART III

 

 

 

 

Item 10.

 

Directors, and Executive Officers of the Registrantand Corporate Governance

 

58

65

Item 11.

 

Executive Compensation

 

58

65

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

59

65

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

59

66

Item 14.

 

Principal Accountant Fees and Services

 

59

66

PART IV

 

 

 

 

Item 15.

 

Exhibits and Financial Statement Schedules

 

60

67

SIGNATURES

 

61

68

EXHIBIT INDEX

 

 

 

1




PART I

ITEM 1.                BUSINESS
(Dollars in thousands)

General

AAR CORP. and its subsidiaries are referred to herein collectively as “AAR,” “Company,” “we,” “us,” and “our” unless the context indicates otherwise. AAR was founded in 1951, organized in 1955 and reincorporated in Delaware in 1966. We are a diversified provider of products and services to the worldwide aviation/aerospaceaviation and defense industries. We conduct our business activities primarily through six 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.

In connection with filing this Form 10-K, we have re-namedWe report our reportable segments and have changed the composition of some of the businesses within these segments. The Inventory and Logistic Services segment is now part of the Aviation Supply Chain segment; the Maintenance, Repair and Overhaul segment name has not changed, however, we have changed the composition of the businesses within the segment; the Manufacturing segment is now called the Structures and Systems segment; and the Aircraft and Engine Sales and Leasing segment is now called the Aircraft Sales and Leasing segment.

Results for our aircraft component repair business, which were previously reportedactivities in the Maintenance, Repair and Overhaul segment, are now reported in the Aviation Supply Chain segment. Results for our industrial gas turbine business, which also were previously reported in the Maintenance, Repair and Overhaul segment, are now reported in the Structures and Systems segment. Results for our engine sales and leasing business, which were previously reported in the Aircraft and Engine Sales and Leasing segment, are now reported in the Aviation Supply Chain segment.

The changes to our reportable segments were necessary to align our reportable segments consistent with the way our Chief Executive Officer now evaluates performance and the way we are internally organized. We believe these changes will provide enhanced transparency to our airframe maintenance activities, which are becoming a more material part of AAR as a result of our occupancy of an airframe maintenance facility in Indianapolis, Indiana. Further, it combines the performance of our aircraft component repair business with our parts distribution, program and logistics businesses, which is consistent with how we present these products and services to the marketplace. We changed the name of our Manufacturing segment to Structures and Systems, which better defines the products and services offered by this segment of our Company.

Our four business segments are:segments: (i) Aviation Supply Chain, comprised primarily of business activities conducted through AAR Parts Trading, Inc., AAR Services, Inc., AAR Allen Services, Inc., a wholly-owned subsidiary 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) Structures and Systems, comprised primarily of business activities conducted through AAR Manufacturing, Inc., and (iv) Aircraft Sales and Leasing, comprised of business activities primarily conducted through AAR Aircraft & Engine Sales & Leasing, Inc.

Aviation Supply Chain

Activities in our Aviation Supply Chain segment include the purchase and sale of a wide variety of new, overhauled and repaired engine and airframe parts and components for our aviationairline and defense customers. We also repair and overhaul a wide variety of avionics, instruments, 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 Aviation 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 Aviation 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 repair and overhaul of most types of landing gear for commercialour airline and defense customers. In June 2004, we entered intoWe have a long-term agreementlease to occupy a portion of an airframe maintenance facility in Indianapolis, Indiana (the Indianapolis Maintenance Center or IMC), which is owned by the Indianapolis AircraftAirport Authority (IAA). We believe the IMC is one of the most efficient and 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. We currently occupyAt May 31, 2007, we occupied and arewere performing maintenance activities in threeseven bays and occupyoccupied certain office space within the IMC. We have options for seven


three additional bays and additional office space under a lease which expires in December 2014, with a ten-year renewal option. The lease agreement contains early termination rights for AAR and the IAA, which may be exercised in specified circumstances. We believe the IMC is one of the most efficient and 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. 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, 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 Roswell, New Mexico. In this segment, we purchase replacement parts from original equipment manufacturers and suppliers that are used in our maintenance, repair and overhaul operations. We have ongoing arrangements with original equipment manufacturers (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 Aviation Supply Chain segment.

Structures and Systems

Activities in our Structures 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 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. We provideDuring fiscal 2007, we decided to exit our non-core industrial turbine engine overhaulbusiness located in Frankfort, New York, and parts supply services to industrial gas and steam turbine operators and for certain military engines.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 Sales and Leasing

Activities in our Aircraft Sales and Leasing segment include the sale or lease of used commercial jet aircraft. In this segment, eachEach 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 domestic and foreign airlines and aircraft leasing companies. Activitiescompanies for our own account or in the Aircraft 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, 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 Aviation Supply Chain, Maintenance, Repair and Overhaul, and Structures 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 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 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

For each of our reportable segments, we market and sell aviation products and services primarily through our own employees. In certain regions of the world,markets, we rely on foreign sales representatives to market and sellassist in the sale of our products and services. The principal customers for our products and services in the Aviation 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 Structures 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 Sales and Leasing segment include domestic and foreign commercial airlines and aircraft 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 European Aviation 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, fivefour are in the Aviation Supply Chain segment, fourfive are in the Maintenance, Repair and Overhaul segment, and fivethree are in the Structures and Systems segment. Of the eightsix EASA licensed repair stations, threetwo are in the Aviation Supply Chain segment, three are in the Maintenance, Repair and Overhaul


segment and two areone is in the Structures 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 Aviation 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 Aircraft Salesrepair 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 Structures 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 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, 2005,2007, backlog believed to be firm was approximately $160,400$319,700 compared to $162,400$243,200 at May 31, 2004.2006. Approximately $151,800$268,300 of this backlog is expected to be filled within the next 12 months.

On June 16, 2005, we announced that our Cargo Systems operating unit was selected to provide cargo handling systems for the new A400M Military Transport Aircraft. We are teaming with Pfalz Flugzeugwerke GmbH of Speyer, Germany on the program. Initial sales of the cargo systems together with estimated revenue from spare parts sales and service are scheduled to begin in fiscal 2007. Our portion of revenue to be generated from the program is expected to exceed $300,000 through fiscal 2015, based on sales projections for the A400M. Airbus Military currently has orders for 188 A400M’s from eight governments, including France and Germany, with deliveries scheduled to begin in 2008. This contract is not included in our May 31, 2005 backlog.

Employees

At May 31, 2005,2007, we employed approximately 2,6003,900 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 $252,168 (33.7%$325,280 (30.7% of total sales), $222,558 (34.5%$293,778 (33.2% of total sales), and $170,191 (28.4%$249,216 (33.7% of total sales) in fiscal years 2005, 20042007, 2006 and 2003,2005, 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 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.

Available InformationAdditional Information

For additional information concerning our business segments, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business Segment Information” in


Note 1315 of Notes to Consolidated Financial Statements under Item 8, “Financial Statements and Supplementary Data”, below.

Our internet address is www.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 Sales and Leasing segment and parts distribution activities in the Aviation Supply Chain segment are conducted from a building 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, Georgia,Georgia; Jacksonville, Florida,Florida; Garden City, New York and London, England, and we own a building near Schiphol International Airport in the Netherlands to support activities in the Aviation Supply Chain segment.

Our principal activities in the Maintenance, Repair and Overhaul activitiessegment are conducted at facilities leased by us located in Indianapolis, Indiana,Indiana; Oklahoma City, Oklahoma,Oklahoma; Miami, Florida andFlorida; Roswell, New Mexico.Mexico and Hot Springs, Arkansas.

Our principal activities in the Structures and Systems segment are conducted at facilities owned by us in Clearwater, Florida (subject to an industrial revenue bond),; Cadillac and Livonia, MichiganMichigan; 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 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”) 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 it)them), removal of any free phase liquids encountered in the ground, provision ofproviding notices of groundwater contamination migration to off-site property owners, and other actions determined by the MDEQ or the 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 accompanied 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 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 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. The subsidiary declined to perform certain work whichrequired by the Order requires whichthat the subsidiary believes is based on claims previously 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 201201” (the Michigan “cleanup law”).

The subsidiary has charged to operations approximately $200 in expenses incurred related to the performance of environmental investigations under the Order. The subsidiary conducted work under the Order in addition to the work required to be performed as noted above. The subsidiary has received some funds from an insurance carrier to reimburse it for work done bya portion of the subsidiary under the 1985 Consent Decree.subsidiary’s costs. The subsidiary sought furthercoverage from another insurance company and that carrier is paying a portion of defense costs, but has reserved its rights on coverage for the matters in the June 14, 2002 MDEQ letter and the Order.litigation noted below. The insurance carrier denied coverage and refused to provide a defense on the basis that the work being performed is with respect to an alleged release that occurred after the executionsubsidiary has filed suit against one of the 1985 Consent Decree. The subsidiary is evaluating the optioninsurance carriers for breach of bringing suit against the insurance carrier for provision ofcontract and other relief and recently reached a defense and for coverage. The subsidiary, priorsettlement.

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-CE05-18853-CE.. In its complaint, the MDEQ seeks to enforce the Order against the subsidiary and seeks 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 (approximately $1,800) from both the subsidiary and the Company and seeks a declaratory judgment that theyboth are both 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’sattorney 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.


7




Supplemental Item:

EXECUTIVE OFFICERS OF THE REGISTRANT

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

Name

 

 

 

Age

 

Present Position with the Company

 

 

David P. Storch

5254

Chairman and Chief Executive Officer, Director

Timothy J. Romenesko

50

 

President and Chief ExecutiveOperating Officer, Director

Richard J. Poulton

42

Vice President, Chief Financial Officer and Treasurer

Howard A. Pulsifer

 

6264

 

Vice President, General Counsel Secretary

Timothy J. Romenesko

48

Vice President and Chief Financial OfficerSecretary

James J. Clark

 

4547

 

Group Vice President, Aviation Supply Chain

Michael J. Mark McDonaldSharp

 

45

 

Group Vice President, StructuresController and Systems; Maintenance, Repair and OverhaulChief 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.

On January 12, 2005, we announced that Chairman Ira A. Eichner will retire from our BoardMr. Poulton was appointed Vice President, Chief Financial Officer and Treasurer effective June 1, 2007. Previously he served as Vice President of Directors effective October 19, 2005. The BoardAcquisitions 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 Directors has expressed its intent to elect Mr. Storch as Chairman of the Board upon Mr. Eichner’s retirement.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, Aviation Supply Chain since 2005. Previously, he served 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, StructuresController and Systems; Maintenance, Repair and OverhaulChief Accounting Officer since 2005.1999. Previously, he served as Group Vice President, Manufacturing from 2003 to 2005, and previous to that he served as General ManagerController of AAR Mobility Systems from 2000 to 2003 and as Vice President of Operationsthe Company from 1996 to 2003.1999. Prior to AAR,joining the Company he was 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.

812




PART II

ITEM 5.                MARKET FOR REGISTRANT’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, 20052007 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 2 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 2005 and 2004 we did not purchase any of our equity securities.

The table below sets forth for each quarter of the past two fiscal years the reported high and low closing market prices of our Common Stock on the New York Stock Exchange.

 

Fiscal 2005

 

Fiscal 2004

 

 

Fiscal 2007

 

Fiscal 2006

 

Per Common Share

 

Market Prices

 

Market Prices

 

 

Market Prices

 

Market Prices

 

Quarter

 

High

 

Low

 

High

 

Low

 

 

High

 

Low

 

High

 

Low

 

First

 

$

11.35

 

$

8.96

 

$

8.34

 

$

4.72

 

 

$

25.17

 

$

19.50

 

$

17.97

 

$

14.94

 

Second

 

13.67

 

10.85

 

11.38

 

7.30

 

 

27.69

 

22.24

 

20.94

 

15.10

 

Third

 

14.53

 

10.81

 

16.37

 

10.25

 

 

31.52

 

26.32

 

26.42

 

20.50

 

Fourth

 

16.04

 

11.59

 

13.09

 

8.72

 

 

33.55

 

27.40

 

29.00

 

24.05

 

 

 

 

 

 

 

 

 

 

 

913




ITEM 6.                SELECTED FINANCIAL DATA

(In thousands, except per share amounts)

 

 

For the Year Ended May 31,

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

 

RESULTS OF OPERATIONS

 

 

 

 

 

 

 

 

 

 

 

 

Sales from continuing operations

 

$

747,848

 

$

644,469

 

$

599,842

 

$

629,783

 

$

837,563

 

 

Pass through sales1

 

 

 

 

 

20,596

 

 

Total sales

 

747,848

 

644,469

 

599,842

 

629,783

 

858,159

 

 

Gross profit

 

120,826

 

100,618

 

77,700

2

14,664

2

135,870

 

 

Operating income (loss)

 

33,492

 

20,281

 

908

2

(78,607

)2

41,705

 

 

Gain on extinguishment of debt

 

3,562

 

 

 

 

 

 

Interest expense

 

16,917

 

18,691

 

19,416

 

19,679

 

21,767

 

 

Income (loss) from continuing operations5

 

18,572

 

4,565

 

(10,578

)

(57,119

)

19,464

 

 

Loss from discontinued operations5

 

(3,119

)

(1,061

)

(1,832

)

(1,820

)

(933

)

 

Net income (loss)

 

15,453

 

3,504

 

(12,410

)

(58,939

)

18,531

 

 

Share data:

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) per share—basic:

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) from continuing operations

 

$

0.58

 

$

0.14

 

$

(0.33

)

$

(2.02

)

$

0.72

 

 

Loss from discontinued operations

 

(0.10

)

(0.03

)

(0.06

)

(0.06

)

(0.03

)

 

Earnings (loss) per share—basic

 

$

0.48

 

$

0.11

 

$

(0.39

)

$

(2.08

)

$

0.69

 

 

Earnings (loss) per share—diluted:

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (loss) from continuing operations

 

$

0.55

 

$

0.14

 

$

(0.33

)

$

(2.02

)

$

0.72

 

 

Loss from discontinued operations

 

(0.09

)

(0.03

)

(0.06

)

(0.06

)

(0.03

)

 

Earnings (loss) per share—diluted

 

$

0.46

 

$

0.11

 

$

(0.39

)

$

(2.08

)

$

0.69

 

 

Cash dividends per share

 

$

0.00

 

$

0.00

 

$

0.03

 

$

0.16

 

$

0.34

 

 

Weighted average common shares outstanding—basic

 

32,297

 

32,111

 

31,852

 

28,282

3

26,913

 

 

Weighted average common

 

 

 

 

 

 

 

 

 

 

 

 

shares outstanding—diluted

 

36,205

 

32,392

 

31,852

 

28,282

3

26,985

 

 

FINANCIAL POSITION

 

 

 

 

 

 

 

 

 

 

 

 

Total cash and cash equivalents

 

$

50,338

 

$

41,010

 

$

29,154

 

$

34,522

 

$

13,809

 

 

Working capital

 

314,517

 

300,943

 

192,837

 

286,192

 

352,731

 

 

Total assets

 

732,230

 

709,292

 

686,621

 

710,199

 

701,854

 

 

Short-term recourse debt

 

2,123

 

2,656

 

59,729

 

42,525

 

13,652

 

 

Short-term non-recourse debt

 

1,622

 

736

 

32,527

 

 

 

 

Long-term recourse debt

 

199,919

 

217,434

4

164,658

 

217,699

 

179,987

 

 

Long-term non-recourse debt

 

27,240

 

31,232

 

 

 

 

 

Total recourse debt

 

202,042

 

220,090

 

224,387

 

260,224

 

193,639

 

 

Stockholders’ equity

 

314,744

 

301,684

 

294,988

 

310,235

 

340,212

 

 

Number of shares outstanding at
end of year

 

32,586

 

32,245

 

31,850

 

31,870

3

26,937

 

 

Book value per share of common stock

 

$

9.66

 

$

9.36

 

$

9.26

 

$

9.73

 

$

12.63

 

 

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

2004

 

2003

 

RESULTS OF OPERATIONS

 

 

 

 

 

 

 

 

 

 

 

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 POSITION

 

 

 

 

 

 

 

 

 

 

 

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, we purchased factory-new products on behalf of our customers from original equipment manufacturers. These products were purchased from the manufacturerfiscal 2007 and “passed through” to our customers at our cost. In December 2000, these inventory management programs were discontinued.


2During fiscal 2003, and 2002, we recorded $5,360$7,652 and $75,900,$5,360, respectively, of impairment charges related to engines and engine and airframe parts. DuringA portion of the fiscal 2002, we recorded special charges2007 charge related to an aircraft. See Note 13 of $10,100.Notes to Consolidated Financial Statements.

32In 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.

53                       During 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.

114In 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 DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

(Dollars in thousands)

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 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. Sales also include the sales 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 derived from the repair and overhaul of most commercial landing gear types and aircraft maintenance and storage. Cost of sales consists principally of 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 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. Sales in this segment are also derived from the repair, overhaul and sale of parts for industrial gas and steam turbine operators and certain military engines. 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 cost of product (aircraft), 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,

 

 

 

2005

 

2004

 

2003

 

Sales:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

390,060

 

$

349,527

 

$

358,412

 

Maintenance, Repair and Overhaul

 

111,932

 

106,416

 

93,415

 

Structures and Systems

 

200,717

 

163,557

 

130,628

 

Aircraft Sales and Leasing

 

45,139

 

24,969

 

17,387

 

 

 

$

747,848

 

$

644,469

 

$

599,842

 

Business Environment and Trends

During fiscal 2004 and 2005, the worldwide airline industry experienced an increase in air traffic as available seat miles, revenue passenger miles and load factors all improved. This improvement in air traffic has been driven primarily by worldwide economic growth and is measured against the depressed levels in fiscal 2002 and 2003, which were negatively affected by terrorism, war and disease outbreaks in Asia.

Although air traffic has improved and most air carriers have been successful in reducing their cost structures, many large U.S. airlines continue to report substantial losses due to historically high fuel prices and a highly competitive pricing environment. These losses, coupled with weak balance sheets, may cause further U.S. airline restructurings, which may have a negative impact on future operating results.


Lower cost carriers have been successful in gaining market share from the major U.S. carriers and several of them are reporting profits. Low cost carriers generally have little to no infrastructure to support their maintenance requirements, which we believe will create additional opportunities for third-party maintenance providers.

Over the last three years, sales of our manufactured products and performance-based logistics and supply chain management services to the U.S. defense department and its contractors increased to $252,168 in fiscal 2005, from $222,558 and $170,191 in fiscal 2004 and 2003, respectively. The increase in sales was driven by the U.S. military’s buildup and increased demand for supply chain management services. Although it remains difficult for us to predict the extent and duration of the military buildup and the impact on our operating 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.

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) relatively high fuel prices and its impact on our commercial customers’ financial position; (3) declining market values for aviation products and equipment; (4) difficulties in re-leasing or selling aircraft and engines that are currently being leased; (5) inability of our Indianapolis airframe maintenance business to capture market share in the highly competitive airframe maintenance market; (6) lack of assurance that sales to the U.S. defense department, its agencies and its contractors (which were 33.7% of total sales in fiscal 2005), will continue at levels previously experienced, including the mix of products sold; (7) access to the debt and equity capital markets and the ability to draw down funds under financing agreements; (8) non-compliance with restrictive and financial covenants contained in certain of our loan agreements; (9) 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; (10) competition from other companies, including original equipment manufacturers, some of which have greater financial resources than us; (11) exposure to product liability and property claims that may be in excess of our substantial liability insurance coverage; and (12) the outcome of any pending or future material litigation or environmental proceedings.

Results of Operations

Fiscal 2005 Compared with Fiscal 2004

Consolidated sales for fiscal 2005 were $747,848, which represents an increase of $103,379 or 16.0% compared to fiscal 2004.

In the Aviation Supply Chain segment, fiscal 2005 sales increased $40,533 or 11.6% compared to fiscal 2004. The sales increase reflects increased demand for engine and airframe parts support as a result of improved conditions in the worldwide commercial aviation industry as well as increased market penetration in Europe and Asia.

In the Maintenance, Repair and Overhaul segment, sales increased $5,516 or 5.2% compared to fiscal 2004. The sales increase is attributable to operations at our Indianapolis airframe maintenance facility which commenced operations in January 2005.

In the Structures and Systems segment, sales increased $37,160 or 22.7% compared to fiscal 2004. We continue to experience strong sales to the U.S. defense department for products supporting deployment


activities and expect this strong performance to continue into future quarters, although not likely at the level experienced during fiscal 2005. We also experienced increased demand for cargo systems and composite structures primarily due to successful sales and marketing efforts.

In the Aircraft Sales and Leasing segment, sales increased $20,170 or 80.8% compared to fiscal 2004. The increase in sales was principally driven by the sale of our interest in certain aircraft for approximately $15,000 at essentially book value.

Consolidated gross profit increased $20,208 or 20.1% compared with the prior fiscal year. The increase in gross profit is primarily attributable to the increase in sales and an increase in the gross profit margin to 16.2% from 15.6% in the prior year. The gross profit margin percentage increased primarily due to a change in the mix of inventories sold within the Aviation Supply Chain segment, partially offset by a $900 pre-tax charge recorded during the fourth quarter of fiscal 2005 related to the write-down of an aircraft as a result of a renegotiated lease with an airline customer operating under bankruptcy protection.

Operating income increased $13,211 or 65.1% compared with the prior fiscal year due to the increase in gross profit, partially offset by an increase in selling, general and administrative expenses. During fiscal 2005, selling, general and administrative expenses increased $7,350 or 9.1% primarily due to increased resources to support our growth and a $667 pension curtailment expense recorded during the fourth quarter of fiscal 2005 as a result of a change to our cash balance pension plan. As a percentage of sales, selling, general and administrative expenses declined from 12.5% to 11.8%.

During the first quarter of fiscal 2005, we retired $6,890 of 6.875% notes payable due in December 2007 and $8,000 of 2.875% convertible notes due in February 2024. The notes were repurchased for $13,638, and we charged $257 of related capitalized financing costs, resulting in a net gain of $995. During the fourth quarter of fiscal 2005, the term of a non-recourse note payable was extended to November 1, 2009 and the outstanding principal balance was reduced by the lender in the amount of $2,567. The reduction in the outstanding principal balance of $2,567 and the $995 net gain on the early extinguishment of the 6.875% and 2.875% notes are reflected in “Gain on extinguishment of debt”.

Interest expense declined $1,774 or 9.5% due to lower overall outstanding borrowings, partially offset by $500 of additional interest expense recorded during the first quarter of fiscal 2005 associated with a litigation settlement.

During the second quarter of fiscal 2005, we recorded a favorable federal income tax adjustment of $1,575. In October 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law and included a number of federal income tax reforms, including an extension of the foreign tax credit carryforward period from five years to ten years. In previous fiscal years, we had established a deferred tax valuation allowance of $1,575 against foreign tax credits expiring in fiscal year 2006. As a result of the new ten-year carryforward period established by the Act, we now expect to utilize the foreign tax credits and recorded a $1,575 credit to the provision for income taxes during the second quarter of fiscal 2005.

During the third quarter of fiscal 2005, upon completion of our fiscal 2004 Federal income tax return, we determined the Company qualified for additional tax benefits of $496 related to higher than estimated margin on fiscal 2004 export activities. Similarly, we recorded a $604 benefit during the third quarter of last year which primarily related to additional tax benefits from fiscal 2003 export activities.

Income from continuing operations was $18,572 for fiscal 2005 or an increase of $14,007 over 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 have classified its results as discontinued operations. During the fiscal year ended May 31, 2005, the loss from discontinued operations was $3,119 or $0.09 per diluted share and is comprised of the operating loss, net of tax, of $798 and the loss on disposal, net of tax, of $2,321.

Net income was $15,453 for fiscal 2005 compared to $3,504 in the prior year.


Fiscal 2004 Compared with Fiscal 2003

Consolidated sales for fiscal 2004 were $644,469, which represents an increase of $44,627 or 7.4% compared to fiscal 2003.

In the Aviation Supply Chain segment, fiscal 2004 sales decreased $8,885 or 2.5% compared to fiscal 2003. At certain of our component repair facilities, demand for component repairs from our commercial airline customers had not recovered, and as a result we experienced lower sales compared to the prior year. We also experienced lower sales of parts to general aviation customers as a result of our strategic decision to de-emphasize certain lower margin products. Within this segment, sales increased to the U.S. military and its contractors for spares and logistics support as well as to commercial customers for engine parts.

In the Maintenance, Repair and Overhaul segment, fiscal 2004 sales increased $13,001 or 13.9% compared with fiscal 2003. The increase in sales compared to the prior year was 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.

In the Structures and Systems segment, fiscal 2004 sales increased $32,929 or 25.2% compared to fiscal 2003. The increase in sales compared to the prior year was due to record shipments of our manufactured products which support the U.S. military deployment activities. In the Structures and Systems 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 Sales and Leasing segment, fiscal 2004 sales increased $7,582 or 43.6% primarily as a result of increased demand for advisory services.

Consolidated gross profit increased $22,918 or 29.5% compared with the prior year. The increase in our consolidated gross profit was primarily due to the increase in sales and an increase in our consolidated gross profit margin to 15.6% from 13.0% in the prior year. During the fourth quarter of fiscal 2004, we wrote off an investment in a joint venture and the associated $1,269 pre-tax charge was recorded in cost of sales. The gross margin percentage increased in the engine parts business within the Aviation Supply Chain segment primarily due to the mix of inventories sold and in the Structures and Systems 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 charge recorded in May 2003.

Operating income increased $19,373 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 $3,259 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 $725 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.


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 secured credit arrangements, which 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 also may be negatively affected by 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, 2005, our liquidity and capital resources included cash of $50,338 and working capital of $314,517. As of May 31, 2005, $9,830 of cash was restricted to support letters of credit. At May 31, 2005, we had $50,000 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, 2005, we had $26,207 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 well as outstanding letters of credit. As of May 31, 2005, unrestricted cash and amounts available to us under our secured credit arrangement and accounts receivable securitization program totaled $118,280.

We continually evaluate various financing arrangements on commercially reasonable terms that would 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 year ended May 31, 2005, we generated $50,938 of cash from operations primarily due to net income and depreciation and amortization of $43,403; a reduction in equipment on lease of $19,956 principally reflecting $15,000 received from the sale of our interest in certain aircraft; and an increase in accounts payable of $19,244 reflecting increased inventory levels and timing of cash disbursements, partially offset by an increase in accounts receivable of $17,596 reflecting increased sales during the fourth quarter as well as an increase to inventories of $12,013 reflecting investments made in support of new programs.

During the year ended May 31, 2005, our investing activities used $17,584 principally reflecting capital expenditures of $13,033 and investments made in aircraft joint ventures of $12,380, partially offset by proceeds from the sale of the engine component repair business of $7,700. We expect fiscal 2006 capital expenditures to be $15,000 to $20,000, principally reflecting increased investments in manufacturing capabilities to support recently awarded contracts and other growth initiatives. We expect to make additional investments in joint ventures during fiscal 2006.

During the year ended May 31, 2005, our financing activities used $24,037 of cash primarily due to a reduction in borrowings of $24,055 reflecting the early retirement of notes for $19,660 and other scheduled principal payments.


Contractual Obligations and Off-Balance Sheet Arrangements

A summary of contractual obligations and off-balance sheet arrangements as of May 31, 2005 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

 

2006

 

2007

 

2008

 

2009

 

2010

 

2010

 

On Balance Sheet:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt

 

$

200,632

 

$

713

 

$

743

 

$

68,157

 

$

8,716

 

$

200

 

$

122,103

 

Non-recourse Debt

 

28,862

 

1,622

 

1,928

 

2,047

 

2,173

 

21,092

 

 

Bank Borrowings

 

1,410

 

1,410

 

 

 

 

 

 

Off Balance Sheet:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Aviation Equipment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Leases

 

38,149

 

10,887

 

18,302

 

3,840

 

3,840

 

1,280

 

 

Facilities and Equipment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Leases

 

25,408

 

6,521

 

6,293

 

5,223

 

3,995

 

3,205

 

171

 

Garden City Operating Lease

 

31,783

 

1,388

 

1,423

 

1,458

 

1,495

 

1,532

 

24,487

 

Purchase Obligations

 

75,555

 

71,085

 

3,657

 

718

 

42

 

37

 

16

 

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, 2005 was approximately $13,175.

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 may 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’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.

18




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 20052007, 2006 and 2004,2005, we did not utilize derivative financial instruments to offset these risks.

At May 31, 2005, $26,2072007, $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, 2005,2007, 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 20052007 would not have reducedhad an impact on our pre-tax income by approximately $32results of operations as we had no borrowings outstanding under this agreement during fiscal 2005.2007.

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’ 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.

1925




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, 20052007 and 20042006 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, 2005.2007. These consolidated financial statements are the responsibility of the Company’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, 20052007 and 2004,2006 and the results of their operations and their cash flows for each of the years in the three-year period ended May 31, 2005,2007, in conformity with accounting principlesU.S. generally accepted in the United States of America.accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of May 31, 2005,2007, 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 20, 200519, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

KPMG LLP

Chicago, Illinois
July 20, 2005

20Chicago, Illinois

July 19, 2007

26




AAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

 

 

(In thousands except per share data)

 

Sales:

 

 

 

 

 

 

 

Sales from products

 

$

632,132

 

$

524,061

 

$

494,984

 

Sales from services

 

94,364

 

93,236

 

82,617

 

Sales from leasing

 

21,352

 

27,172

 

22,241

 

 

 

747,848

 

644,469

 

599,842

 

Costs and operating expenses:

 

 

 

 

 

 

 

Cost of products

 

535,164

 

444,846

 

434,910

 

Cost of services

 

72,709

 

76,301

 

69,592

 

Cost of leasing

 

19,149

 

22,704

 

17,640

 

Selling, general and administrative and other

 

87,902

 

80,552

 

77,293

 

 

 

714,924

 

624,403

 

599,435

 

Equity in earnings of aircraft joint ventures

 

568

 

215

 

501

 

Operating income

 

33,492

 

20,281

 

908

 

Gain on extinguishment of debt

 

3,562

 

 

 

Interest expense

 

(16,917

)

(18,691

)

(19,416

)

Interest income

 

1,502

 

1,748

 

1,836

 

Income (loss) before provision for income taxes

 

21,639

 

3,338

 

(16,672

)

Provision (benefit) for income taxes

 

3,067

 

(1,227

)

(6,094

)

Income (loss) from continuing operations

 

18,572

 

4,565

 

(10,578

)

Discontinued operations, net of tax:

 

 

 

 

 

 

 

Operating loss

 

(798

)

(1,061

)

(1,832

)

Loss on disposal

 

(2,321

)

 

 

Loss from discontinued operations

 

(3,119

)

(1,061

)

(1,832

)

Net income (loss)

 

$

15,453

 

$

3,504

 

$

(12,410

)

Earnings (loss) per share—basic:

 

 

 

 

 

 

 

Earnings (loss) from continuing operations

 

$

0.58

 

$

0.14

 

$

(0.33

)

Loss from discontinued operations

 

(0.10

)

(0.03

)

(0.06

)

Earnings (loss) per share—basic

 

$

0.48

 

$

0.11

 

$

(0.39

)

Earnings (loss) per share—diluted:

 

 

 

 

 

 

 

Earnings (loss) from continuing operations

 

$

0.55

 

$

0.14

 

$

(0.33

)

Loss from discontinued operations

 

(0.09

)

(0.03

)

(0.06

)

Earnings (loss) per share—diluted

 

$

0.46

 

$

0.11

 

$

(0.39

)

 

 

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.

2127




AAR CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

ASSETS

 

May 31,

 

 

May 31,

 

 

2005

 

2004

 

 

2007

 

2006

 

 

(In thousands)

 

 

(In thousands)

 

Current assets:

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

40,508

 

$

33,697

 

 

$

83,317

 

$

121,738

 

Restricted cash

 

9,830

 

7,313

 

Accounts receivable

 

127,121

 

104,661

 

 

181,691

 

136,272

 

Inventories.

 

204,990

 

206,899

 

Inventories

 

244,661

 

245,690

 

Equipment on or available for short-term lease

 

50,487

 

40,346

 

 

97,932

 

77,902

 

Deposits, prepaids and other

 

13,934

 

11,714

 

 

12,607

 

12,986

 

Deferred tax assets

 

27,672

 

27,574

 

 

25,513

 

29,866

 

Total current assets

 

474,542

 

432,204

 

Total current assets.

 

645,721

 

624,454

 

Property, plant and equipment, at cost:

 

 

 

 

 

 

 

 

 

 

Land

 

4,828

 

5,542

 

 

4,828

 

4,828

 

Buildings and improvements

 

53,921

 

58,868

 

 

69,564

 

57,842

 

Equipment, furniture and fixtures

 

128,792

 

129,793

 

Equipment, furniture and fixtures.

 

159,313

 

139,863

 

 

187,541

 

194,203

 

 

233,705

 

202,533

 

Accumulated depreciation

 

(116,067

)

(112,337

)

 

(145,518

)

(129,896

)

 

71,474

 

81,866

 

 

88,187

 

72,637

 

Other assets:

 

 

 

 

 

 

 

 

 

 

Goodwill, net

 

44,416

 

44,421

 

Equipment on long-term lease

 

67,663

 

84,271

 

Investment in aircraft joint venture

 

11,234

 

 

Other

 

62,901

 

66,530

 

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

 

 

186,214

 

195,222

 

 

333,725

 

281,728

 

 

$

732,230

 

$

709,292

 

 

$

1,067,633

 

$

978,819

 

 

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

2228




AAR CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

May 31,

 

 

May 31,

 

2005

 

2004

 

 

2007

 

2006

 

 

(In thousands)

 

 

(In thousands)

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

Short-term debt

 

$

1,410

 

$

1,896

 

 

$

 

$

161

 

Current maturities of long-term debt

 

713

 

760

 

 

51,366

 

200

 

Current maturities of non-recourse long-term debt

 

1,622

 

736

 

 

22,879

 

1,928

 

Accounts payable

 

77,015

 

57,582

 

 

110,239

 

97,002

 

Accrued liabilities

 

79,265

 

70,287

 

 

72,022

 

88,497

 

Total current liabilities

 

160,025

 

131,261

 

 

256,506

 

187,788

 

Long-term debt, less current maturities

 

199,919

 

217,434

 

 

232,863

 

293,263

 

Non-recourse debt.

 

27,240

 

31,232

 

Non-recourse debt

 

20,748

 

25,313

 

Deferred tax liabilities

 

18,089

 

17,628

 

 

40,121

 

25,357

 

Retirement benefit obligation

 

653

 

683

 

Deferred income and other

 

11,560

 

9,370

 

Other liabilities and deferred income

 

23,152

 

24,381

 

 

257,461

 

276,347

 

 

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 35,853 and 34,525 shares, respectively

 

35,853

 

34,525

 

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

 

42,230

 

40,789

 

Capital surplus

 

189,617

 

172,681

 

 

289,673

 

274,211

 

Retained earnings

 

162,229

 

146,776

 

 

256,052

 

197,392

 

Treasury stock, 3,267 and 2,280 shares at cost, respectively

 

(50,497

)

(36,030

)

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

 

(79,813

)

(69,664

)

Unearned restricted stock awards

 

(2,679

)

(1,376

)

 

 

(6,169

)

Accumulated other comprehensive loss—

 

 

 

 

 

Cumulative translation adjustments

 

(1,797

)

(1,647

)

Minimum pension liability

 

(17,982

)

(13,245

)

Accumulated other comprehensive loss.

 

(13,899

)

(13,842

)

 

314,744

 

301,684

 

 

494,243

 

422,717

 

 

$

732,230

 

$

709,292

 

 

$

1,067,633

 

$

978,819

 

 

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

2329




AAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE THREE YEARS ENDED MAY 31, 20052007

 

 

 

 

 

 

 

 

 

 

 

 

 

Unearned

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unearned

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted

 

Other

 

 

 

 

Common Stock

 

Treasury Stock

 

Capital

 

Retained

 

Stock

 

Comprehensive

 

Comprehensive

 

 

Common Stock

 

Treasury Stock

 

Capital

 

Retained

 

Stock

 

Comprehensive

 

Comprehensive

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Surplus

 

Earnings

 

Awards

 

Income (Loss)

 

Income (Loss)

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Surplus

 

Earnings

 

Awards

 

Income (Loss)

 

Income

 

 

(In thousands)

 

 

(In thousands)

 

Balance, May 31, 2002

 

33,568

 

$ 33,568

 

 

1,698

 

 

$ (26,986

)

$ 165,188

 

$ 156,479

 

 

$ (1,138

)

 

 

$ (16,876

)

 

 

 

 

 

Net loss

 

 

 

 

 

 

 

 

(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

 

 

 

 

 

 

 

 

 

 

 

 

 

6,980

 

 

 

6,980

 

 

Minimum pension liability, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

(9,270

)

 

 

(9,270

)

 

Comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$ (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

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

1,597

 

 

 

1,597

 

 

Minimum pension liability, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

2,677

 

 

 

2,677

 

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$  7,778

 

 

Balance, May 31, 2004

 

34,525

 

$ 34,525

 

 

2,280

 

 

$ (36,030

)

$ 172,681

 

$ 146,776

 

 

$ (1,376

)

 

 

$ (14,892

)

 

 

 

 

 

 

34,525

 

$

34,525

 

 

2,280

 

 

$

(36,030

)

$

172,681

 

$

146,776

 

 

$

(1,376

)

 

 

$

(14,892

)

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

15,453

 

 

 

 

 

 

 

 

$ 15,453

 

 

 

 

 

 

 

 

 

 

15,453

 

 

 

 

 

 

 

 

$

15,453

 

 

Treasury stock

 

 

 

 

987

 

 

(14,467

)

 

 

 

 

 

 

 

 

 

 

 

Exercise of stock options and stock awards

 

1,328

 

1,328

 

 

 

 

 

16,936

 

 

 

 

 

 

 

 

 

 

 

 

1,328

 

1,328

 

 

987

 

 

(14,467

)

16,936

 

 

 

 

 

 

 

 

 

 

 

Restricted stock activity

 

 

 

 

 

 

 

 

 

 

(1,303

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,303

)

 

 

 

 

 

 

 

Adjustment for net translation loss

 

 

 

 

 

 

 

 

 

 

 

 

 

(150

)

 

 

(150

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(150

)

 

 

(150

)

 

Minimum pension liability, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

(4,737

)

 

 

(4,737

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(4,737

)

 

 

(4,737

)

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$ 10,566

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

10,566

 

 

Balance, May 31, 2005

 

35,853

 

$ 35,853

 

 

3,267

 

 

$ (50,497

)

$ 189,617

 

$ 162,229

 

 

$ (2,679

)

 

 

$ (19,779

)

 

 

 

 

 

 

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

30




AAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

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.

24




AAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

 

 

(In thousands)

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income (loss)

 

$

15,453

 

$

3,504

 

$

(12,410

)

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

 

 

 

 

 

 

 

Depreciation and amortization

 

27,950

 

26,680

 

27,172

 

Deferred tax provision (benefit)—continuing operations

 

1,613

 

(2,826

)

(6,657

)

Loss on disposal of business, net of tax

 

2,321

 

 

 

Impairment charges

 

 

 

5,360

 

Changes in certain assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

(17,596

)

(41,374

)

16,517

 

Inventories

 

(12,013

)

15,602

 

17,755

 

Equipment on or available for short-term lease

 

(3,154

)

(3,233

)

5,232

 

Equipment on long-term lease

 

19,956

 

(218

)

(1,796

)

Accounts payable

 

19,244

 

6,642

 

(2,841

)

Accrued liabilities and taxes on income

 

5,907

 

13,143

 

(14,423

)

Other, primarily pension contributions and prepaids

 

(8,743

)

(3,348

)

824

 

Net cash provided from operating activities

 

50,938

 

14,572

 

34,733

 

Cash flows provided from (used in) investing activities:

 

 

 

 

 

 

 

Property, plant and equipment expenditures

 

(13,033

)

(10,286

)

(9,930

)

Proceeds from disposal of assets

 

7

 

92

 

113

 

Proceeds from disposal of business

 

7,700

 

 

 

Proceeds from sale of facilities, net

 

 

16,922

 

2,969

 

Investment in leveraged leases

 

122

 

245

 

1,694

 

Other, primarily investment in aircraft joint ventures

 

(12,380

)

(1,347

)

(815

)

Net cash provided from (used in) investing activities

 

(17,584

)

5,626

 

(5,969

)

Cash flows used in financing activities:

 

 

 

 

 

 

 

Proceeds from borrowings

 

 

89,701

 

24,000

 

Reduction in borrowings

 

(24,005

)

(94,615

)

(56,643

)

Financing costs

 

(34

)

(3,459

)

(715

)

Other

 

2

 

 

(707

)

Net cash used in financing activities

 

(24,037

)

(8,373

)

(34,065

)

Effect of exchange rate changes on cash

 

11

 

31

 

(67

)

Increase (decrease) in cash and cash equivalents.

 

9,328

 

11,856

 

(5,368

)

Cash and cash equivalents, beginning of year

 

41,010

 

29,154

 

34,522

 

Cash and cash equivalents, end of year

 

$

50,338

 

$

41,010

 

$

29,154

 

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

2531




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. is a diversified provider of products and services to the worldwide aviation/aerospaceaviation and defense industries. Products and services include: aviation supply chain and parts support programs; maintenance, repair and overhaul of aircraft and landing gear; design and manufacture of composite structures and specialized mobility and cargo systems;systems and composite structures; and aircraft sales and leasing. We serve commercial and governmental aircraft fleet operators, original equipment manufacturers and independent 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)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.

Certain 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 and Other Intangible Assets”, goodwill and other intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment tests.


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

1.   Summary of Significant Accounting Policies (Continued)

The amount reported under the caption “Goodwill and 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. For the annual goodwill impairment


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

1.   Summary of Significant Accounting Policies (Continued)

test, we compare an estimate of 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,

 

 

May 31,

 

 

2005

 

2004

 

 

2007

 

2006

 

Aviation Supply Chain

 

$

20,094

 

$

20,099

 

 

$

20,136

 

$

20,110

 

Maintenance, Repair and Overhaul

 

5,838

 

5,838

 

 

14,940

 

5,838

 

Structures and Systems

 

18,484

 

18,484

 

 

37,611

 

18,484

 

 

$

44,416

 

$

44,421

 

 

$

72,687

 

$

44,432

 

 

Stock Options

We have an employee stock option plan which is more fully describedThe increase in goodwill during fiscal 2007 was attributable to the acquisitions discussed in Note 4. 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.

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,

 

 

 

2005

 

2004

 

2003

 

Net income (loss) as reported

 

$

15,453

 

$

3,504

 

$

(12,410

)

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

 

2,370

 

323

 

142

 

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

 

(5,315

)

(2,188

)

(2,758

)

Pro forma net income (loss)

 

$

12,508

 

$

1,639

 

$

(15,026

)

Earnings (loss) per share—basic:

 

 

 

 

 

 

 

 

As reported

 

$

0.48

 

$

0.11

 

$

(0.39

)

 

Pro forma

 

$

0.39

 

$

0.05

 

$

(0.47

)

Earnings (loss) per share—diluted:

 

 

 

 

 

 

 

 

As reported

 

$

0.46

 

$

0.11

 

$

(0.39

)

 

Pro forma

 

$

0.38

 

$

0.05

 

$

(0.47

)


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

1.   Summary of Significant Accounting Policies (Continued)

The fair value weighted average per share of stock options granted during fiscal 2005, 2004 and 2003 was $7.73, $4.93 and $3.82, respectively. The fair value of each option grantcompete 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

 

 

 

2005

 

2004

 

2003

 

Risk-free interest rate

 

4.1

%

3.1

%

2.5

%

Expected volatility of common stock

 

65.0

%

67.2

%

64.0

%

Dividend yield

 

0.0

%

0.0

%

1.6

%

Expected option term in years

 

4.0

 

4.0

 

4.0

 

being amortized over a five year period.

Cash and Cash Equivalents

We consider all highly liquid investments with maturities of three months or less to be cash equivalents. At May 31, 20052007 and 20042006, cash equivalents of approximately $9,830$0 and $11,317,$40,535, respectively, representsconsist of investments in funds holding high-quality commercial paper. The carrying amount of cash equivalents approximates fair value at May 31, 20052007 and 2004,2006, respectively. As of May 31, 2005 and 2004, $9,830 and $7,313, respectively,  of cash was restricted to support letters of credit.

Transfer of Financial AssetsMarketable Securities

SFAS No. 140, “AccountingDuring the fourth quarter of fiscal 2007, we sold an investment in equity securities that was classified as available for Transferssale. These securities were acquired in fiscal 2007, and Servicinghad a cost basis of Financial Assets and Extinguishments of Liabilities”, 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). On November 30, 2004, the agreement with LaSalle was amended and the facility was increased to $50,000. The current facility expires in March 2006 and bears interest at LIBOR plus 300 basis points. Under the program, on each business day certaingain of our subsidiaries sell all new eligible receivables to an entity that$915 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, 2005income and 2004, accounts receivable sold underother on the program were $0.consolidated statements of 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’ equity as a component of accumulated other comprehensive income (loss).


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

1.   Summary of Significant Accounting Policies (Continued)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 about Fair Value of Financial 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,

 

 

2005

 

2004

 

 

2007

 

2006

 

Raw materials and parts

 

$

43,576

 

$

45,823

 

 

$

55,702

 

$

58,421

 

Work-in-process

 

30,528

 

20,419

 

 

36,580

 

30,651

 

Purchased aircraft, parts, engines and components held for
sale

 

130,886

 

140,657

 

 

152,379

 

156,618

 

 

$

204,990

 

$

206,899

 

 

$

244,661

 

$

245,690

 

 

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.


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 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’ 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 fiveseven narrow-body and threetwo 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 11)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 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.

All but oneof the aircraft in our aircraft portfolio isare currently on lease and we expect to lease that aircraft upon completion of maintenance activities.lease. Future rent due to us under non-cancelable leases for aircraft and engines during each of the next five fiscal years is $19,417 in 2006, $12,780 in 2007, $9,437$29,025 in 2008, $7,567$26,492 in 2009, $23,357 in 2010, $17,059 in 2011 and $2,833$16,948 in 2010.2012.

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 Lease

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

We have ownership rights to the leased asset and are entitled to the tax deduction for depreciation on the leased asset 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)

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

Income taxes

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

Supplemental Information on Cash Flows

Supplemental information on cash flows follows:

 

For the Year Ended May 31,

 

 

For the Year Ended May 31,

 

 

2005

 

2004

 

2003

 

 

2007

 

2006

 

2005

 

Interest paid

 

$

13,764

 

$

15,246

 

$

17,604

 

 

$

13,650

 

$

13,588

 

$

13,764

 

Income taxes paid

 

591

 

740

 

3,460

 

 

1,948

 

1,303

 

591

 

Income tax refunds and interest received

 

1,138

 

1,026

 

865

 

 

1,221

 

1,137

 

1,138

 

 

InDuring 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 with the aircraft.note holder.

During fiscal 20052007, 2006 and 2004,2005, treasury stock increased $14,467$10,149, $19,167 and $9,232,$14,467, respectively, principally reflecting the cashlessimpact from the exercise of 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

SFAS No. 123 (revised 2004) “Share-Based Payment” (“SFAS No. 123(R)”) was issued in December 2004. SFAS No. 123(R) addresses the accounting 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 instruments 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, is to be measured based on the grant-date fair value of those instruments. That cost will be recognized as compensation expense over the service period, which would normally be the vesting period. On April 15, 2005,In September 2006, the Securities and Exchange Commission (SEC) adopted a rule that delays required stock option and other share plan expensing under SFASissued Staff Accounting Bulletin No. 123(R)108 (SAB 108). UnderSAB 108 provides guidance regarding the SEC’s rule, public companies will be required to implement SFAS No. 123(R) at the beginningprocess by which misstatements in financial statements are evaluated for purposes of their first fiscal year that begins after June 15, 2005. We will adopt the provisions of SFAS No. 123(R) in the first quarter of fiscal 2007, and anticipate that adoption of the standard will result in approximately $1,100 of pre-tax compensation expense in fiscal 2007 for current unvested stock options.determining whether financial statement restatement is

31





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) 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.

Reclassification

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

2.   Financing Arrangements

Revolving Credit Facility

We maintainOn August 31, 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. (Merrill Lynch).up to $35,000, not to exceed $175,000 in total. The maximum amount available to us under this agreement is $30,000 and as of May 31, 2005 and 2004, the amount available was $26,207 and $22,449, respectively. Availability is based on a formula of qualifying assets as well as outstanding letters of credit and borrowings are secured by substantially all of our inventories and certain other assets. The facility expires on June 1, 2007, however, Merrill Lynch may terminateAugust 31, 2010 and borrowings under the facility in the event of an adverse change to our business. The facility bearsbear interest at LIBOR plus 250125 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 at May 31, 2005 and 2004, 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,

 

 

2005

 

2004

 

2003

 

 

2006

 

2005

 

Maximum amount borrowed

 

$

21,000

 

$

24,008

 

$

41,700

 

 

$

25,000

 

$

21,000

 

Average daily borrowings

 

5,248

 

7,878

 

32,661

 

 

7,216

 

5,248

 

Average interest rate during the year

 

5.47

%

3.98

%

3.4

%

 

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 is as follows:

 

 

May 31,

 

 

 

2007

 

2006

 

Recourse debt

 

 

 

 

 

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

 

$

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

 

Notes payable due May 15, 2011 with interest at 8.39% payable semi-annually on June 1 and December 1

 

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

 

16,355

 

16,355

 

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

 

284,229

 

293,463

 

Current maturities of recourse debt

 

(51,366

)

(200

)

Long-term recourse debt

 

$

232,863

 

$

293,263

 

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

 

(22,879

)

(1,928

)

Long-term non-recourse debt

 

$

20,748

 

$

25,313

 

During fiscal 2007 and 2006, we retired $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 767-300 aircraft. 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 (see Note 13).


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

2.   Financing Arrangements (Continued)

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

 

 

May 31,

 

 

 

2005

 

2004

 

Recourse debt

 

 

 

 

 

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

 

$

47,380

 

$

54,370

 

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

 

20,000

 

20,000

 

Mortgage loan due July 1, 2008 with interest at 6.25%

 

10,144

 

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

 

Convertible notes payable due February 1, 2024 with interest at 2.875% payable semi-annually on February 1 and August 1

 

67,000

 

75,000

 

Other, primarily industrial revenue bonds, (secured by trust indentures on property, plant and equipment) with a weighted average interest of approximately 3.12% at May 31, 2005

 

1,108

 

3,197

 

Total recourse debt

 

200,632

 

218,194

 

Current maturities of recourse debt

 

(713

)

(760

)

Long-term recourse debt

 

$

199,919

 

$

217,434

 

Non-recourse debt

 

 

 

 

 

Non-recourse note payable due November 2009 with interest at 6.00%

 

$

28,862

 

$

31,968

 

Current maturities of non-recourse debt

 

(1,622

)

(736

)

Long-term non-recourse debt

 

$

27,240

 

$

31,232

 

On July 15, 2005, we refinanced the mortgage loan with Principal Commercial Funding, LLC. Proceeds from the new loan were $11,000 and the term of the financing is 10 years with a fixed rate of 5.01%. Under the terms of the new loan, interest payments are due monthly with a balloon payment of $11,000 due August 1, 2015. The new loan payable is secured by our Wood Dale, Illinois facility. At May 31, 2005, the net book value of our Wood Dale, Illinois facility is $15,104.

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 semi-annuallysemiannually 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 atbased on a conversion rate of 33.9789 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


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

2.   Financing Arrangements (Continued)

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 this transaction were $2,585 and are being amortized over a six-year period. Net proceeds from this transaction were $72,415 and were used in part 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.

During the first quarter of fiscal 2005, we retired $6,890 of 6.875% notes payable due in December$15,000 note payable. The note matures September 23, 2007 and $8,000bears interest at LIBOR plus 275 basis points. On July 19, 2007, we refinanced this note payable. Proceeds of 2.875% convertible notes due in February 2024. The notesthe new loan were repurchased for $13,638,$17,000 and we recorded charges of $257 to write-off capitalized financing costs, resulting in a net gain of $995.

During the fourth quarter of fiscal 2005, 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.

The mortgage loan due August 1, 2015 is secured by our Wood Dale, Illinois facility. At May 31, 2007, the net book value of our Wood Dale, Illinois facility is $14,593. The non-recourse note payable was extended to November 1, 2009 anddue December 2007 is secured by a wide-body aircraft. At May 31, 2007, the outstanding principal balance was reduced by the lender in the amountnet book value of $2,567. The reduction in the outstanding principal balance of $2,567 and the $995 net gain on the early extinguishment of the 6.875% and 2.875% notes are presented as gain on extinguishment of debt.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 $713 in 2006, $743 in 2007, $68,157$51,366 in 2008, $8,716$200 in 2009, and $200 in 2010.2010, $55,108 in 2011 and $0 in 2012. Our long-term recourse debt was estimated to have a fair value of approximately $205,800$300,000 at May 31, 2005.2007. The fair value was determined using available market information.

34




3.   Stock-Based Compensation

We provide stock-based awards under the AAR CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Dollars in thousands, except per share amounts)

2.   Financing Arrangements (Continued)

Guarantees

On February 28, 2005,Stock Benefit Plan (“Stock Benefit Plan”) which has been approved by our stockholders. Under this plan, we sold an interest in certain aircraftare authorized to issue stock options to employees and non-employee directors that allow the grant recipients to purchase shares of common stock at a customer (“purchaser”) for $15,000 cash proceeds. The cash proceeds approximatedprice not less than the net bookfair market value of the aircraft. The purchaser borrowed $12,000common stock on the date of grant. Generally, stock options awarded under the plan expire ten years from the date of grant and are exercisable in either four or five equal annual increments commencing one year after the date of grant. We issue new common stock upon 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 third party lendercareer with the Company. Restricted stock typically vests over periods of three to financeten 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 purchase. We agreedgrant is earned. All restricted stock which has not vested carries full dividend and voting rights.

Typically, stock options and restricted stock are subject to unconditionally guaranteeforfeiture 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 lenderadoption of SFAS No. 123(R). Compensation cost is measured based on the purchaser’s payment of principal and interest when due under the loan up to an amount not to exceed $11,250 (the “Aggregate Guaranteed Amount”). However, the Aggregate Guaranteed Amount shall be reduced by the unpaid principal portiongrant date fair value of the loanaward 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 an aircraft on the later of (A) the date the lender obtains a first priority perfected security interest in such aircraft, and (B) the date on which a new lease has been entered into for such aircraft. In addition, we shall be unconditionally released from our obligations under the guaranty at the earlier of (A) March 2,stock options granted prior to June 1, 2006 and (B) the later of (x) the date the lender obtains a first priority perfected security interestwas included as pro forma disclosure in the aircraft and (y)consolidated financial statements.

On April 11, 2006, our Board of Directors approved the date on which new leases have been entered into for the aircraft. The maximum potential amount of future payments that we may be required to make under the guaranty is $11,250. However, we have the right (in lieu of making a payment under the guarantee) to purchase from the third party lender allacceleration of the lender’s right, titlevesting 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 interest in, to and under the loan documents, including, without limitation, all of the lender’s rights and interest in and to the aircraft and the other assets securing the loan, for a purchase price equal to the unpaid principal and interest due under the loan.

3.   Income Taxes

2009 became fully exercisable effective May 1, 2006. The provision (benefit) for income taxes on continuing operations includes the following components:

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

Current:

 

 

 

 

 

 

 

Federal

 

$

1,034

 

$

1,329

 

$

293

 

State

 

420

 

270

 

270

 

 

 

1,454

 

1,599

 

563

 

Deferred

 

1,613

 

(2,826

)

(6,657

)

 

 

$3,067

 

$

(1,227

)

$

(6,094

)

The deferred tax 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.


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

3.   Income TaxesStock-Based Compensation (Continued)

The provision (benefit) for income taxes on continuing operations differs fromaccelerated vesting enabled us to reduce the amount computed by applyingof compensation expense that would otherwise be required to be recognized in our consolidated statements of operations with respect to these options upon the U.S. federal statutory income tax rateadoption of 35% for fiscal 2005, 2004 and 2003, for the following reasons:

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

Provision (benefit) for income taxes at the federal statutory rate

 

$

7,574

 

$

1,168

 

$

(5,835

)

Tax benefits on exempt earnings from export sales

 

(3,430

)

(2,625

)

(1,220

)

State income taxes, net of federal benefit and refunds

 

270

 

175

 

176

 

Changes in valuation allowance

 

(1,575

)

637

 

938

 

Reduction in income tax accrued liabilities

 

 

(350

)

 

Other, net

 

228

 

(232

)

(153

)

Provision (benefit) for income taxes on continuing operations

 

3,067

 

(1,227

)

(6,094

)

During the third quarter of fiscal 2005, we recorded a favorable federal income tax adjustment of $496. Upon completion of the fiscal 2004 federal tax return in February 2005, we determinedSFAS No. 123(R). The aggregate expense that we qualified for additional tax benefits related to export activities. Similarly, we recorded a $604 federal income tax benefit during the third quarter of fiscal 2004 which primarily related to additional tax benefits from export activities in fiscal 2003.

In previous fiscal years, we had established a deferred tax valuation allowance of $1,575 against foreign tax credits expiring in fiscal year 2006. Aswas eliminated as a result of the new ten-year carryforward period (formerly five years) established byacceleration was approximately $1,800. The acceleration resulted in a non-cash, one-time pre-tax stock compensation expense of $362 in the American Jobs Creation Act of 2004, we now expect to utilize the foreign tax credits and recorded a $1,575 credit to the provision for income taxes during the secondfourth quarter of fiscal 2005.2006.

DuringOn 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 2004, we recorded a reduction2006 and 2005 other than reload options, which resulted from the exercise of original stock options granted in income tax expenseprior years. Effective May 1, 2006, the reload provision was eliminated from substantially all outstanding stock option arrangements.

The weighted average fair value of $350. This adjustmentstock 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 reversalperiod of federaltime that the stock options granted are expected 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 state income tax accruals which were no longer considered required.earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to our stock option plan for the 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.   Income TaxesStock-Based Compensation (Continued)

Deferred tax liabilities and assets result primarilyThe adoption of SFAS No. 123(R) on June 1, 2006 reduced our operating income from continuing operations by $240 for the differencesyear ended May 31, 2007.

A summary of changes in stock option activity for the timing of the recognition for transactions between financial reporting and income tax purposes and consist of the following components:three years ended May 31, 2007 follows (shares in thousands):

 

 

May 31,

 

 

 

2005

 

2004

 

Deferred tax assets-current attributable to:

 

 

 

 

 

Inventory costs

 

$

29,977

 

$

31,129

 

Employee benefits (accruals)

 

(4,061

)

(5,109

)

Other

 

1,756

 

1,554

 

Total deferred tax assets-current

 

$

27,672

 

$

27,574

 

Deferred tax assets-noncurrent attributable to:

 

 

 

 

 

Postretirement benefits (liabilities)

 

$

10,122

 

$

7,572

 

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

 

24,682

 

34,858

 

Valuation allowance

 

 

(1,575

)

Total deferred tax assets-noncurrent

 

$

34,804

 

$

40,855

 

Total deferred tax assets

 

$

62,476

 

$

68,429

 

Deferred tax liabilities attributable to:

 

 

 

 

 

Depreciation

 

$

(45,424

)

$

(50,612

)

Leveraged leases

 

(7,469

)

(7,871

)

Total deferred tax liabilities

 

$

(52,893

)

$

(58,483

)

Net deferred tax assets

 

$

9,583

 

$

9,946

 

 

 

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, 2005,2007, we have determined that the realizationhad $953 of our 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, primarilyunrecognized compensation expense related to depreciation. Atstock options that will be amortized over an average period of five years.

The following table provides additional information regarding stock options outstanding as of May 31, 2005, we had federal net operating loss carryforwards of approximately $60,703 of which $34,990 will expire after fiscal 2022, $12,561 will expire after fiscal 2023 and $13,152 will expire after fiscal 2024.2007 (shares in thousands):

 

 

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

 

 

4.   Common Stock and Stock Options

We have established stock option plans for our officers and key employees. Stock option awards under the AAR Stock Benefit Plan typically expire ten years from the date of grant or earlier upon termination of employment, become exercisable in five equal increments on successive grant anniversary dates at the New York Stock Exchange closing common stock price on the date of grant and are accompanied by reload features and, for certain individuals, stock rights exercisable in the event of a change in control of the Company.

37

42




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

4.   Common Stock and Stock Options3.   Stock-Based Compensation (Continued)

A summary of changes in stock options (in thousands) granted to officers,Restricted Stock

We provide executives and other key employees an opportunity to be awarded restricted shares. The award is contingent upon the achievement of certain performance objectives, including net income and nonemployee directorsreturn 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 stock option plans forthis program.

In addition to the three years ended May 31, 2005 follows:

 

 

Number of
Shares

 

Weighted Average
Exercise Price

 

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

 

 

Granted

 

 

845

 

 

 

14.66

 

 

Exercised

 

 

(1,186

)

 

 

11.03

 

 

Surrendered/expired/cancelled

 

 

(206

)

 

 

16.37

 

 

Outstanding, May 31, 2005 (3,414 exercisable)

 

 

4,607

 

 

 

$

15.17

 

 

The following table provides additional information regarding stock options (in thousands) outstanding as of May 31, 2005:

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

 

 

1,224

 

 

 

7.6

 

 

 

215

 

 

 

$

8.38

 

 

$12.26 – 18.38

 

 

2,328

 

 

 

4.4

 

 

 

2,144

 

 

 

$

15.53

 

 

$18.39 – 24.50

 

 

1,034

 

 

 

3.0

 

 

 

1,034

 

 

 

$

23.18

 

 

$24.51 – 30.63

 

 

21

 

 

 

1.9

 

 

 

21

 

 

 

$

27.40

 

 

 

 

 

4,607

 

 

 

4.9

 

 

 

3,414

 

 

 

$

17.48

 

 

The AAR CORP. Stock Benefit Plan also provides for the grant ofperformance-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


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

4.   Common Stock and Stock Options (Continued) (Continued)

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,

 

 

 

2005

 

2004

 

2003

 

Shares of restricted stock granted

 

150

 

202

 

 

Weighted average per share fair value

 

$

16.04

 

$

6.96

 

 

2.9 years.

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, 2005 follows:

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

Expense

 

$

1,295

 

$

516

 

$

330

 

Forfeitures (income)

 

(32

)

(17

)

(111

)

Net

 

$

1,263

 

$

499

 

$

219

 

The AAR CORP. Employee Stock PurchaseShareholders’ Rights 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.

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):

 

 

May 31, 2005

 

 

 

Outstanding

 

Available

 

Total

 

Stock Benefit Plan (officers, directors and key employees)

 

 

5,301

 

 

 

3,205

 

 

8,506

 

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”) 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.

39On June 20, 2006 our Board of Directors authorized us to purchase up to 1,500 shares of our common stock on the market. This action superseded our previous stock repurchase plan which had remaining authorization to purchase 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)

4.   Common Stock   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 Stock Options (Continued)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

 

On September 21, 1990, the 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, 2005,2007, we had purchased 1,745,000 shareshave determined that the realization of our common stock ondeferred tax assets is more likely than not, and that a valuation allowance is not required based upon our history of operating earnings, the open market under these programs at an average pricenature of $14.00 per sharecertain of our deferred tax assets, our expectations for continued future earnings and have remaining authorizationthe scheduled reversal of deferred tax liabilities, primarily related to purchase 1,255,000 shares (see Note 2).depreciation.

5.   Earnings Per Share

The computation of basic earnings per share is based on the weighted average number of common shares outstanding during each period. The computation of diluted earnings per share is based on the weighted average number of common shares outstanding during the period plus, when their effect is dilutive, incremental shares consisting of shares subject to stock options, shares issuable upon vesting of restricted stock awards and shares issuedissuable 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 account for contingently convertible debt usinguse the “if converted” method set forth in SFAS No. 128, “Earnings Per Share”Share,” for calculating diluted earnings per share.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 to equityinto common shares at the beginning of the period and is added to outstanding common shares.period. For comparative purposes, diluted earnings per share information for all quartersperiods since the convertible debt securities were issued in fiscal 2005 give effect to the adoption ofFebruary 2004 have been restated as required by EITF No. 04-08. Diluted earnings per share information for fiscal 2004 quarters ended subsequent to the February 2004 issuance of our convertible debt securities do not give effect to the provisions of EITF No. 04-08 because the effect is anti-dilutive.


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

5.   Earnings Per Share (Continued)

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, 20052007 (shares in thousands).

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

Income (loss) from continuing operations

 

$

18,572

 

$

4,565

 

$

(10,578

)

Loss from discontinued operations, net of tax

 

(3,119

)

(1,061

)

(1,832

)

Net income (loss)

 

$

15,453

 

$

3,504

 

$

(12,410

)

Basic shares:

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

32,297

 

32,111

 

31,852

 

Earnings (loss) per share—basic:

 

 

 

 

 

 

 

Earnings (loss) from continuing operations

 

$

0.58

 

$

0.14

 

$

(0.33

)

Loss from discontinued operations, net of tax

 

(0.10

)

(0.03

)

(0.06

)

Earnings (loss) per share—basic

 

$

0.48

 

$

0.11

 

$

(0.39

)

Net income (loss)

 

$

15,453

 

$

3,504

 

$

(12,410

)

Add: After-tax interest on convertible debt

 

1,230

 

 

 

Net income (loss) for diluted EPS calculation

 

$

16,683

 

$

3,504

 

$

(12,410

)

Diluted shares:

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

32,297

 

32,111

 

31,852

 

Additional shares from the assumed exercise of stock options

 

304

 

281

 

 

Additional shares from the assumed conversion of

 

 

 

 

 

 

 

convertible debt

 

3,604

 

 

 

Weighted average common shares outstanding—diluted

 

36,205

 

32,392

 

31,852

 

Earnings (loss) per share—diluted:

 

 

 

 

 

 

 

Earnings (loss) from continuing operations

 

$

0.55

 

$

0.14

 

$

(0.33

)

Loss from discontinued operations, net of tax

 

(0.09

)

(0.03

)

(0.06

)

Earnings (loss) per share—diluted

 

$

0.46

 

$

0.11

 

$

(0.39

)

 

 

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, 20052007, 2006 and 2004,2005, respectively, options to purchase 3.4 milion31 thousand, 1.2 million and 3.23.4 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.

4146




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

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 retirees.

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 yearsyear 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 eligible 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’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)

The following table sets forth the change in projected benefit obligations for all of our pension plans:

 

 

May 31,

 

 

 

2005

 

2004

 

Change in benefit obligation:

 

 

 

 

 

Benefit obligation at beginning of year

 

$

77,044

 

$

77,425

 

Service cost

 

2,841

 

2,834

 

Interest cost

 

4,899

 

4,483

 

Plan participants’ contributions

 

228

 

223

 

Amendments

 

(3,754

)

 

Net actuarial loss (gain)

 

14,313

 

(3,795

)

Benefits paid

 

(4,742

)

(4,126

)

Benefit obligation at end of year

 

$

90,829

 

$

77,044

 

The projected benefit obligation is measured at May 31 of each year using the following weighted average assumptions:

 

 

May 31,

 

 

 

2005

 

2004

 

Domestic plans:

 

 

 

 

 

Discount rate

 

5.40

%

6.50

%

Compensation increase rate

 

3.00

 

3.00

 

Non-domestic plans:

 

 

 

 

 

Discount rate

 

4.25

%

5.50

%

Compensation increase rate

 

3.00

 

3.25

 

Obligations and Funded Status

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

 

May 31,

 

 

May 31,

 

 

2005

 

2004

 

 

2007

 

2006

 

Change in benefit obligation:

 

 

 

 

 

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 year

 

$

89,447

 

$

84,427

 

Change in plan assets:

 

 

 

 

 

 

 

 

 

 

Fair value of plan assets at beginning of year

 

$

60,834

 

$

51,431

 

 

$

75,121

 

$

69,859

 

Actual return on plan assets

 

6,925

 

6,407

 

 

8,471

 

6,731

 

Employer contributions

 

6,614

 

6,899

 

 

2,947

 

4,180

 

Plan participants’ contributions

 

228

 

223

 

 

271

 

252

 

Benefits paid

 

(4,742

)

(4,126

)

 

(5,835

)

(5,901

)

Translation

 

5,070

 

 

Fair value of plan assets at end of year

 

$

69,859

 

$

60,834

 

 

$

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, discounting those expected payments using a theoretical zero-coupon spot yield curve derived from a universe of high-quality bonds as of the measurement date, and solving for the single equivalent discount rate that resulted in the same projected benefit obligation. Constraints were applied with respect to callability and credit quality. In addition, 3% of the bonds were deemed outliers due to questionable pricing information and consequently were excluded from consideration.

Plan Assets

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

 

May 31,

 

Target Asset

 

 

May 31,

 

Target Asset

 

 

2005

 

2004

 

Allocation

 

 

2007

 

2006

 

Allocation

 

Equity securities

 

61

%

65

%

 

45 - 65

%

 

 

 

67

%

 

 

65

%

 

 

45–75

%

 

Fixed income securities

 

32

 

29

 

 

25 - 55

%

 

 

 

21

 

 

 

27

 

 

 

25–55

%

 

Other (fund-of funds hedge fund)

 

7

 

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 2005 and 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 following table summarizes our estimated future pension benefits by fiscal 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 $5,000$2,000 to $7,000$4,000 during fiscal 2006.

The following table sets forth all of the defined benefit plan’s funded status and the amount recognized in our Consolidated Balance Sheets:

 

 

May 31,

 

 

 

2005

 

2004

 

Funded status

 

$

(20,970

)

$

(16,210

)

Unrecognized actuarial losses

 

34,050

 

25,886

 

Unrecognized prior service cost

 

1,005

 

1,773

 

Unrecognized transitional obligation

 

 

67

 

Prepaid pension costs

 

$

14,085

 

$

11,516

 

A minimum pension liability adjustment is required when the actuarial present value of accumulated plan benefits exceeds plan assets and accrued pension liabilities. During 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 (loss). During fiscal 2005, we increased the minimum pension liability by $6,475, and $4,737, net of tax, was reported as a component of comprehensive income (loss). The accumulated benefit obligation for all pension plans was $88,600 and $72,905 as of May 31, 2005 and 2004, respectively.


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

6.   Employee Benefit Plans (Continued)

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

 

 

May 31,

 

 

 

2005

 

2004

 

Projected benefit obligation

 

$

90,829

 

$

77,044

 

Accumulated benefit obligation

 

88,600

 

72,905

 

Fair value of plan assets

 

69,859

 

60,834

 

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

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

Service cost

 

$

2,841

 

$

2,834

 

$

2,726

 

Interest cost

 

4,899

 

4,483

 

4,458

 

Expected return on plan assets

 

(5,701

)

(4,886

)

(4,804

)

Amortization of prior service cost

 

295

 

298

 

290

 

Recognized net actuarial loss

 

1,155

 

1,392

 

504

 

Transitional obligation

 

68

 

89

 

92

 

Curtailment

 

667

 

 

 

 

 

$

4,224

 

$

4,210

 

$

3,266

 

The following table summarizes our estimated future pension benefits by fiscal year:

 

 

2006

 

2007

 

2008

 

2009

 

2010

 

2011 to
2015

 

Estimated pension benefits

 

$

8,090

 

$

5,162

 

$

7,399

 

$

6,283

 

$

5,891

 

$

31,134

 

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

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

Domestic plans:

 

 

 

 

 

 

 

Discount rate

 

6.50

%

6.00

%

7.25

%

Rate of compensation increase

 

3.00

 

3.00

 

4.00

 

Expected long-term return on plan assets

 

8.50

 

8.50

 

9.00

 

Non-domestic plans:

 

 

 

 

 

 

 

Discount rate

 

5.50

%

5.25

%

6.00

%

Rate of compensation increase

 

3.25

 

3.25

 

4.00

 

Expected long-term return on plan assets

 

6.50

 

6.50

 

6.50

 


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

6.   Employee Benefit Plans (Continued)2008.

Defined Contribution PlanAdditional Information

The defined contribution plan is a profit sharing plan which is intended to qualifyestimated amounts for our plans that will be amortized from accumulated other comprehensive income into expense over the next fiscal year are 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 in fiscal 2005 and 2004 and $457 in fiscal 2003.follows:

Amortization of net actuarial loss

 

$

727

 

Amortization of prior service cost

 

$

148

 

Postretirement Benefits Other Than Pensions

We provide health and life insurance benefits for certain eligible 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, 2005, 2004 and 2003 included the following components:

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

Interest cost

 

$

76

 

$

47

 

$

58

 

Amortization of prior service cost

 

8

 

8

 

7

 

Amortization of unrecognized loss

 

47

 

 

 

 

 

$

131

 

$

55

 

$

65

 

46




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

6.   Employee Benefit Plans (Continued)

The funded status of the plans at May 31, 2005 and 2004 was as follows:

 

 

May 31,

 

 

 

2005

 

2004

 

Change in benefit obligation:

 

 

 

 

 

Benefit obligation at beginning of year

 

$

1,250

 

$

847

 

Interest cost

 

76

 

47

 

Benefits paid

 

(161

)

(120

)

Unrecognized actuarial loss

 

189

 

476

 

Benefit obligation at end of year

 

$

1,354

 

$

1,250

 

Change in plan assets:

 

 

 

 

 

Fair value of plan assets at beginning of year

 

$

 

$

 

Company contributions

 

161

 

120

 

Benefits paid

 

(161

)

(120

)

Fair value of plan assets at end of year

 

$

 

$

 

Funded status

 

$

(1,354

)

$

(1,250

)

Unrecognized actuarial loss

 

646

 

504

 

Unrecognized prior service cost

 

55

 

63

 

Accrued postretirement costs

 

$

(653

)

$

(683

)

We estimate that our annual postretirement benefit payments will be approximately $200 in each of the next five fiscal years and will be funded with Company contributions. The assumed discount rate used to measure the accumulated postretirementunfunded projected benefit obligation for this plan was 5.4% at May 31, 2005$1,370 and 6.5% at May 31, 2004. The assumed rate of future increases in healthcare costs was 9.0% in fiscal 2005 and 10.0% in fiscal 2004, declining to 5.0% by the year 2011 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 $50$1,363 as of May 31, 2005,2007 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 annual postretirement benefit expense.

7.   Aircraft Joint Venture

DuringInternal 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 quarterthree years of employment. Expense charged to results of operations for Company matching contributions, including profit sharing contributions, was $5,501 in fiscal 2005, we invested2007, $4,216 in a limited liability company, which is accounted for under the equity method of accounting. Our investmentfiscal 2006 and $897 in the limited liability company was made under an agreement with a global financial institution. Our membership interest in this limited liability company is 50% and the primary business of this company is the acquisition, ownership, lease and disposition of certain narrow-body commercial aircraft. Aircraft that are acquired by the company are purchased with cash contributions by the members of the company, and debt financing which is non-recourse to the members of the company. The associated income tax benefit or expense is recorded by the member companies.fiscal 2005.


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

7.   Aircraft Joint Venture (Continued)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 divestiture 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 or expense related to the operations of the ventures is recorded by the member companies.

Distributions from joint ventures are classified as operating or investing activities in the 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 thisthese limited liability companycompanies is as follows:

 

 

For the Year Ended
May 31, 2005

 

Statement of operations information:

 

 

 

 

 

Sales

 

 

$

11,249

 

 

Income before provision for income taxes

 

 

1,136

 

 

 

 

May 31, 2005

 

Balance sheet information:

 

 

 

 

 

Assets

 

 

$

47,309

 

 

Debt

 

 

23,431

 

 

Members’ capital

 

 

21,885

 

 

 

 

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

 

 

During the first quarter of fiscal 2005, weWe also investedhave an investment in aan aircraft joint venture company with a different party. The joint venture company owns an aircraft on lease to a foreign carrier. This aircraft was subject to a note payable to a major financial institution that was guaranteed by AAR; during the third quarter of fiscal 2005, we paid the debt of $6,022 in full.consolidate. We consolidate the financial 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, 2005.2007.

8.   Aviation   Equipment Operating Leaseson 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 support 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 straight-line basis over 10 years to a


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

From time8.   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 portion 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 time we lease aviation equipment (engines and aircraft) from lessors under arrangements that are classified as operating leases. We may also subleasesupport their fleet of CRJ 200 regional jets. Under the aviation equipment to a customer on a short- or long-term basis. 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 may 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 purchaseremaining balance of approximately $5,150 due in two installments ending in August 2009. The deferred payment obligation is included in other liabilities and deferred income on the equipment at any time during a lease at its scheduled purchase option price. The scheduled purchase option values were $20,492 and $30,097 at May 31, 2005 and 2004.

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 $2,107 and $5,800 at May 31, 2005 and 2004. The reduction in loss accrual is attributable to the buyout of leases and the subsequent sale of the underlying aircraft engines during fiscal 2005.consolidated balance sheet.

9.   Commitments and Contingencies

On October 3, 2003, we 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 for 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 other liabilities and deferred income on the 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 Garden City 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, 2007 are as follows:

 

 

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)

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, 2005 is $8,455 and is included in the caption “Deferred income and other” on the Consolidated Balance Sheet.

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

In addition to the aviation equipment operating leases and the Garden City and IMC leases, we lease other facilities and 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, 2005 are as follows:

 

 

Future Minimum Payments

 

Year

 

 

 

Facilities and
Equipment

 

Aviation
Equipment

 

2006

 

 

$

7,909

 

 

 

$

10,887

 

 

2007

 

 

7,716

 

 

 

18,302

 

 

2008

 

 

6,681

 

 

 

3,840

 

 

2009

 

 

5,490

 

 

 

3,840

 

 

2010 and thereafter

 

 

29,395

 

 

 

1,280

 

 

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

 

For the Year Ended May 31,

 

 

For the Year Ended May 31,

 

 

2005

 

2004

 

2003

 

 

2007

 

2006

 

2005

 

Facilities and Equipment

 

$

9,445

 

$

8,193

 

$

6,597

 

 

$

14,412

 

$

12,514

 

$

9,445

 

Aviation Equipment

 

2,629

 

3,051

 

3,117

 

 

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, 20052007 was approximately $13,175.$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.

49




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

10.   Discontinued Operations

During the third quarter of fiscal 2007, we decided to exit our non-core industrial turbine business based in Frankfort, New York. The industrial turbine business is a unit within the Structures and Systems segment and is expected to be sold within 12 months. Net assets of the 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 transactionstransaction 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 the pre-tax operating loss for the three-year period ended May 31,fiscal years 2007, 2006 and 2005 for the discontinued operations are summarized as follows:

 

For the Year Ended May 31,

 

 

For the Year Ended May 31,

 

 

2005

 

2004

 

2003

 

 

2007

 

2006

 

2005

 

Revenues

 

$

5,898

 

$

7,488

 

$

6,496

 

 

$

7,778

 

$

11,766

 

$

13,319

 

Pre-tax operating loss

 

(1,229

)

(1,631

)

(2,819

)

 

$

(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 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 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. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.

13.Impairment Charges

PriorDuring 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, weand were executingsubject to impairment charges recorded in fiscal 2003 and 2002. The fiscal 2007 impairment charge was triggered by our plandecision to reduce our investment in supportaggressively pursue the liquidation of older generation aircraft in line withthis inventory. We made this decision to recognize the commercial airlines’ scheduled retirement plansimpairment due to the impact of persistently high fuel costs and fewer operators on demand 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.

The writedown for 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 writedown for whole engines related to assets that are reportedbetter align human and physical resources with higher potential opportunities in the caption “Equipment on or available for short-term lease” and was determined by comparing the carrying value for each engine to an estimaterapidly growing Aviation Supply Chain segment. We had previously recorded impairment charges 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.

During$5,360 during the fourth quarter of fiscal 2003 we recorded additional impairment chargesand $75,900 during the second quarter of fiscal 2002 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.


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

11.13.   Impairment Charges (Continued)

A summary of the carrying value of impaired inventory and engines, after giving effect to theall impairment charges recorded by us duringin fiscal 2007, 2003 and fiscal 2002 areis as follows:

 

 

May 31,
2005

 

May 31,
2004

 

May 31,
2003

 

November 30,
2001

 

Net impaired inventory and engines

 

$

43,200

 

$

51,500

 

$

56,200

 

 

$

89,600

 

 

 

 

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 2004, and 2003 were $7,900,$3,800, $7,300 and $12,100, respectively,$7,900, respectively.

Other Impairment and $15,600Gain 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 restructuring 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 six-month period endedcarrying value of the aircraft to its estimated net realizable value. At May 31, 2002.2007, the carrying value of this aircraft is $26,430 and is reported in equipment on or available for short term lease on the consolidated balance sheets.

12.14.   Other Noncurrent Assets

At May 31, 20052007 and 2004,2006, other noncurrent assets consisted of the following:

 

May 31,

 

 

May 31,

 

 

2005

 

2004

 

 

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

 

$

10,679

 

$

13,259

 

 

6,303

 

11,026

 

Investment in leveraged lease

 

9,419

 

9,541

 

Investment in aviation equipment

 

8,498

 

9,123

 

Cash surrender value of life insurance

 

7,091

 

6,146

 

Debt issuance costs

 

2,878

 

4,022

 

 

5,327

 

5,956

 

Licenses and rights

 

2,837

 

3,349

 

 

1,871

 

2,357

 

Other

 

21,499

 

21,090

 

 

12,985

 

23,577

 

 

$

62,901

 

$

66,530

 

 

$

69,654

 

$

68,055

 

 

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




13.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 diversified provider of products and services to the global aviation/aerospace industry. 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 salessale 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 and aircraft maintenance and storage.types. Cost of sales consists principally of the cost of product (primarily replacement aircraft parts), direct labor and overhead.

51




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

13.   Business Segment Information (Continued)

Sales in the Structures 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’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. Sales in this segment are also derived from the repair, overhaul and sale of parts for industrial gas and steam turbine operators and certain military engines. 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).

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 has been re-stated to conform with current year presentation and is as follows:

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

Net sales:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

390,060

 

$

349,527

 

$

358,412

 

Maintenance, Repair and Overhaul

 

111,932

 

106,416

 

93,415

 

Structures and Systems

 

200,717

 

163,557

 

130,628

 

Aircraft Sales and Leasing

 

45,139

 

24,969

 

17,387

 

 

 

$

747,848

 

$

644,469

 

$

599,842

 

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

Gross profit:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

67,672

 

$

51,972

 

$

42,686

 

Maintenance, Repair and Overhaul

 

14,414

 

14,351

 

11,600

 

Structures and Systems

 

35,435

 

29,621

 

18,895

 

Aircraft Sales and Leasing

 

3,305

 

4,674

 

4,519

 

 

 

$

120,826

 

$

100,618

 

$

77,700

 


 

 

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

 

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

13.   Business Segment Information (Continued)

 

 

May 31,

 

 

 

2005

 

2004

 

2003

 

Total assets:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

298,477

 

$

287,434

 

$

329,050

 

Maintenance, Repair and Overhaul

 

86,271

 

69,145

 

75,066

 

Structures and Systems

 

97,780

 

93,956

 

70,060

 

Aircraft Sales and Leasing

 

119,581

 

135,598

 

128,761

 

Corporate

 

130,121

 

123,159

 

83,684

 

 

 

$

732,230

 

$

709,292

 

$

686,621

 

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

Capital expenditures:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

3,777

 

$

3,944

 

$

5,004

 

Maintenance, Repair and Overhaul

 

2,817

 

1,650

 

2,176

 

Structures and Systems

 

5,222

 

4,237

 

2,009

 

Aircraft Sales and Leasing

 

48

 

7

 

 

Corporate

 

1,169

 

448

 

741

 

 

 

$

13,033

 

$

10,286

 

$

9,930

 

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

Depreciation and amortization:

 

 

 

 

 

 

 

Aviation Supply Chain

 

$

10,768

 

$

9,764

 

$

9,609

 

Maintenance, Repair and Overhaul

 

2,534

 

2,474

 

1,978

 

Structures and Systems

 

4,481

 

4,001

 

4,017

 

Aircraft Sales and Leasing

 

6,087

 

5,925

 

7,458

 

Corporate

 

4,080

 

4,516

 

4,110

 

 

 

$

27,950

 

$

26,680

 

$

27,172

 

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

 

 

For the Year Ended May 31,

 

 

 

2005

 

2004

 

2003

 

Segment gross profit

 

$

120,826

 

$

100,618

 

$

77,700

 

Selling, general and administrative and other

 

(87,902

)

(80,552

)

(77,293

)

Equity in earnings of aircraft joint ventures

 

568

 

215

 

501

 

Gain on extinguishment of debt

 

3,562

 

 

 

Interest expense

 

(16,917

)

(18,691

)

(19,416

)

Interest income

 

1,502

 

1,748

 

1,836

 

Income (loss) before provision for income taxes

 

$

21,639

 

$

3,338

 

$

(16,672

)

 


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

13.15.   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 before provision for income taxes.

 

 

For the Year Ended May 31,

 

 

 

2007

 

2006

 

2005

 

Segment gross profit

 

$

184,147

 

$

163,221

 

$

120,575

 

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,

 

 

For the Year Ended May 31,

 

 

2005

 

2004

 

2003

 

 

2007

 

2006

 

2005

 

Aviation Supply Chain

 

$

69,027

 

$

66,137

 

$

51,535

 

 

$

75,185

 

$

77,340

 

$

69,027

 

Maintenance, Repair and Overhaul

 

25,976

 

27,370

 

30,953

 

 

32,184

 

31,089

 

25,976

 

Structures and Systems

 

157,165

 

129,051

 

87,703

 

 

217,911

 

185,349

 

154,213

 

 

$

252,168

 

$

222,558

 

$

170,191

 

 

$

325,280

 

$

293,778

 

$

249,216

 

Percentage of total sales

 

33.7

%

34.5

%

28.4

%

 

30.7

%

33.2

%

33.7

%

 

Geographic Data

 

May 31,

 

 

May 31,

 

 

2005

 

2004

 

 

2007

 

2006

 

Long-lived assets:

 

 

 

 

 

 

 

 

 

 

United States

 

$

246,120

 

$

264,987

 

 

$

410,285

 

$

343,121

 

Europe

 

11,378

 

11,932

 

 

11,440

 

11,090

 

Other

 

190

 

169

 

 

187

 

154

 

 

$

257,688

 

$

277,088

 

 

$

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 $178,211 (23.8%$220,974 (20.8% of total sales), $111,902 (17.2%$180,752 (20.4% of total sales) and $142,403 (23.5%$178,025 (24.0% of total sales) in fiscal 2007, 2006 and 2005, 2004 and 2003, respectively.

54





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

14.16.   Selected Quarterly Data (Unaudited)

The unaudited selected quarterly data for fiscal years ended May 31, 20052007 and 20042006 follows.

 

Fiscal 2005

 

 

 

Diluted Earnings

 

Fiscal 2007

Fiscal 2007

 

Quarter

 

 

 

Sales

 

Gross Profit

 

Net Income

 

Per Share

 

 

 

 

Sales

 

Gross Profit

 

Net Income
from
Continuing
Operations

 

Diluted Earnings
Per Share-
Continuing
Operations

 

First

First

 

$

163,773

 

 

$

26,525

 

 

 

$

2,286

 

 

 

$

0.07

 

 

First

 

$

240,242

 

 

$

35,371

 

 

 

$

12,229

 

 

 

$

0.30

 

 

Second

Second

 

176,448

 

 

28,471

 

 

 

4,839

 

 

 

0.14

 

 

Second

 

244,272

 

 

45,903

 

 

 

13,982

 

 

 

0.34

 

 

Third

Third

 

197,701

 

 

30,735

 

 

 

2,595

 

 

 

0.08

 

 

Third

 

270,978

 

 

47,275

 

 

 

15,519

 

 

 

0.37

 

 

Fourth

Fourth

 

209,926

 

 

35,095

 

 

 

5,733

 

 

 

0.17

 

 

Fourth

 

305,677

 

 

55,598

 

 

 

17,717

 

 

 

0.42

 

 

 

$

747,848

 

 

$

120,826

 

 

 

$

15,453

 

 

 

$

0.46

 

 

 

$

1,061,169

 

 

$

184,147

 

 

 

$

59,447

 

 

 

$

1.42

 

 

 

See Note 2 for information regarding gains on extinguishment of debt and Note 10 for information regarding discontinued operations.

 

Fiscal 2004

 

Net Income

 

Diluted Earnings

 

Fiscal 2006

Fiscal 2006

 

Quarter

 

 

 

Sales

 

Gross Profit

 

(Loss)

 

(Loss) Per Share

 

 

 

 

Sales

 

Gross Profit

 

Net Income
from
Continuing
Operations

 

Diluted Earnings
Per Share-
Continuing
Operations

 

First

First

 

$

150,570

 

 

$

21,389

 

 

 

$

(1,996

)

 

 

$

(0.06

)

 

First

 

$

197,073

 

 

$

34,418

 

 

 

$

5,335

 

 

 

$

0.15

 

 

Second

Second

 

157,831

 

 

25,239

 

 

 

916

 

 

 

0.03

 

 

Second

 

215,394

 

 

37,621

 

 

 

7,944

 

 

 

0.22

 

 

Third

Third

 

159,233

 

 

26,476

 

 

 

2,012

 

 

 

0.06

 

 

Third

 

223,398

 

 

43,106

 

 

 

9,195

 

 

 

0.24

 

 

Fourth

Fourth

 

176,835

 

 

27,514

 

 

 

2,572

 

 

 

0.08

 

 

Fourth

 

249,653

 

 

48,076

 

 

 

13,349

 

 

 

0.32

 

 

 

$

644,469

 

 

$

100,618

 

 

 

$

3,504

 

 

 

$

0.11

 

 

 

$

885,518

 

 

$

163,221

 

 

 

$

35,823

 

 

 

$

0.96

 

 

 

15.17.   Allowance for Doubtful Accounts

 

May 31,

 

 

May 31,

 

 

2005

 

2004

 

2003

 

 

2007

 

2006

 

2005

 

Balance, beginning of year

 

$

6,310

 

$

8,663

 

$

10,624

 

 

$

6,466

 

$

5,863

 

$

6,310

 

Provision charged to operations

 

2,391

 

2,771

 

3,140

 

 

1,500

 

2,580

 

2,391

 

Deductions for accounts written off, net of recoveries

 

(2,838

)

(5,124

)

(5,101

)

 

(4,081

)

(1,977

)

(2,838

)

Balance, end of year

 

$

5,863

 

$

6,310

 

$

8,663

 

 

$

3,885

 

$

6,466

 

$

5,863

 

 

5561




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, 2005.2007. 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 concluded that our disclosure controls and procedures are effective as of May 31, 2005,2007, ensuring that information required to be disclosed in the reports that are filed under the Act is recorded, processed, summarized and reported in a timely manner.

There were no changes in our internal control over financial reporting during the fourth quarterthree-month period ended May 31, 20052007 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 accounting principlesU.S. generally accepted in the United States of America.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, 2005.2007. Our assessment of the effectiveness of our internal control over financial reporting as of May 31, 2005,2007, has been audited by KPMG LLP, an independent registered public accounting firm, as stated in its report which is included herein.

56The 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, 2005,2007, 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, 2005,2007, 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, 2005,2007, 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, 20052007 and 2004,2006, 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, 20052007, and our report dated July 20, 200519, 2007 expressed an unqualified opinion on those consolidated financial statements.

KPMG LLP

Chicago, Illinois

July 20, 200519, 2007

57




ITEM 9B.       OTHER INFORMATION

None

None64




PART III

ITEM 10.         DIRECTORS, AND EXECUTIVE OFFICERS OF THE REGISTRANTAND 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 of Directors” in our definitive proxy statement for the 20052007 Annual Meeting of Stockholders.

The information required by this item regarding the Executive Officers of the Company appears under the caption “Executive Officers of the 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 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement for the 20052007 Annual Meeting of Stockholders.

The information required by this item regarding the identification of the Audit Committee as a separately-designated standing committee of the Board is incorporated by reference to the information contained under the caption “Board Committees” in our definitive proxy statement for the 20052007 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 committee financial expert” is incorporated by reference to the information contained under the caption “Board Committees” in our definitive proxy statement for the 20052007 Annual Meeting of Stockholders.

The information required by this 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 Governance Information” in our definitive proxy statement for the 20052007 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 Compensation and Other Information” (but excluding the following sections thereof:, “Compensation Committee’s Report on Executive Compensation” and “Stockholder Return Performance Graph”);Committee Report”, “Employment and Other Agreements” and “Directors’ Compensation” in our definitive proxy statement for the 20052007 Annual Meeting of Stockholders.

58




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

The following table provides information as of May 31, 2005 with respect to the Company’s compensation plans under which equity securities of the Company are authorized for issuance:

 

 

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)

 

Equity compensation plans
approved by security
holders

 

 

4,607

 

 

 

$

15.17

 

 

 

3,205

 

 

Equity compensation plans
not approved by security
holders

 

 

 

 

 

 

 

 

 

 

Total

 

 

4,607

 

 

 

$

15.17

 

 

 

3,205

 

 

 

The information required by this item regarding security ownership of certain beneficial owners and management is incorporated by reference to the information contained under the caption “Security Ownership of Management and Others” in our definitive proxy statement for the 20052007 Annual Meeting of Stockholders.


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

 

 

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)

 

Equity compensation plans approved by security holders

 

 

2,135

 

 

 

$

18.30

 

 

 

3,368

 

 

Equity compensation plans not approved by security holders

 

 

 

 

 

 

 

 

 

 

Total

 

 

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 captions “Board of Directors—Director Independence”“ and “Corporate Governance Information—Related Party Transactions” in our definitive proxy statement for the 2007 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 “Certain Relationships and Related Transactions” in our definitive proxy statement for the 2005 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” in our definitive proxy statement for the 20052007 Annual Meeting of Stockholders.

5966




PART IV

ITEM 15.         EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(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 Andand Supplementary Data”

 

Page

 

Report of Independent Registered Public Accounting Firm

 

2026

 

Financial Statements—AAR CORP. and Subsidiaries:

 

 

 

Consolidated Statements of Operations for the three years ended May 31, 20052007

 

2127

 

Consolidated Balance Sheets as of May 31, 20052007 and 20042006

 

22-2328-29

 

Consolidated Statements of Stockholders’ Equity for the three years ended May 31, 20052007

 

2430

 

Consolidated Statements of Cash Flows for the three years ended May 31, 20052007

 

2531

 

Notes to Consolidated Financial Statements

 

26-5532-61

 

Selected quarterly data (unaudited) for the years ended May 31, 20052007 and 2004

(Note 142006 (Note 16 of Notes to Consolidated Financial Statements)

 

5561

 

 

(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.

6067




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 22, 2005

20, 2007

 

 

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/ David P. Storch

 

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

July 20, 2007

David P. Storch

 

 

/s/ IRA A. EICHNERTimothy J. Romenesko

Chairman of the Board

July 22, 2005

Ira A. Eichner

Director

/s/ DAVID P. STORCH

President and Chief ExecutiveOperating Officer; Director

David P. Storch

Director (Principal Executive Officer)

/s/ TIMOTHY J. ROMENESKO

Vice President and Chief Financial

Timothy J. Romenesko

/s/ Richard J. Poulton

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

Richard J. Poulton

/s/ MICHAELMichael J. SHARPSharp

Vice President and Controller (Principal Accounting Officer)

Michael J. Sharp

(Principal Accounting Officer)

/s/ JAMES G. BROCKSMITH, JR.Michael R. Boyce

Director

Michael R. Boyce

/s/ James G. Brocksmith, Jr.

Director

James G. Brocksmith, Jr.

 

 

/s/ Gerald F. Fitzgerald, Jr.

Director

Gerald F. Fitzgerald, Jr.

/s/ Ronald R. Fogleman

Director

Ronald R. Fogleman

 

 

/s/ JAMESJames E. GOODWINGoodwin

Director

James E. Goodwin

 

 

/s/ MARCPatrick J. WALFISHKelly

Director

Patrick J. Kelly

/s/ Marc J. Walfish

Director

Marc J. Walfish

 

 

/s/ RONALDRonald B. WOODARDWoodard

Director

Ronald B. Woodard

 

 

 

6168




EXHIBIT INDEX

 

Index

 

 

 

Exhibits

 

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, 1999.24

 

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. Amendment thereto dated April 12, 1994, January 13, 1997, July 16,1992, April 11, 2000, May 13, 2002 and October 13, 2004  (filed herewith).

 

 

 

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).

 

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

.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

.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, 1997.11

 

 

 

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, 1989,7 October 12, 1993,7 December 15, 199719 and May 31, 2002.19

 

 

 

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

 

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, 2003,19 March 2, 2004,24 and March 29, 2005.29

 

 

 

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

 

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

 

 

 

4

.7

Form of 2.875% Senior Convertible Note.18

 

 

 

 

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, 2004,24 August 24, 2004,25 and March 29, 2005.29

 

 

 

4

.8

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

 

 

 

 

4.9

 

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

 

 

 

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

 

Form of 2.875% Senior Convertible Note.22

 

 

 

4

.10

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

 

 

 

 

4.11

 

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

 

 

 

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

 




 

4.12

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

4.13

Loan Agreement dated July 15, 2005 between Registrant’s Subsidiary, AAR Wood Dale LLC and Principal Commercial Funding, LLC.30

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, 2001,15 as amended June 27, 2003,19 as amended May 5, 2005 (filed herewith).

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, 19949 and October 9, 1996.12

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 30, 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

 

 

 

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

 




 

 

 

 

10.11*

 

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

 

 

 

 

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, 2003,24 February 27, 2004,24 October 21, 2004,26 November 30, 200427 and December 20, 2004.28

 

 

 

 

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

 

 

 

 

10.19

 

Lease Agreement by and between Indianapolis Airport Authority and AAR Aircraft Services, Inc. dated as of June 14, 2004, as amended January 21, 2005 (filed herewith).

 

 

 

 

10.20*

 

Form of Non-Qualified Stock Option Agreement (filed herewith).

 

 

 

 

10.21*

 

Form of Restricted Stock Agreement (filed herewith).

 

 

 

 

10.22*

 

Form of Performance Restricted Stock Agreement (filed herewith).

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 22, 2005 of David P. Storch, President and Chief Executive Officer of Registrant (filed herewith).




 

 

 

31.2

 

Section 302 Certification dated July 22, 2005 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 22, 2005 of David P. Storch, President and Chief Executive Officer of Registrant (filed herewith).

 

 

 

 

32.2

 

Section 906 Certification dated July 22, 2005 of Timothy J. Romenesko, Vice President and Chief Financial Officer of Registrant (filed herewith).

 

 

 

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:

  1Incorporated by reference to Exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 1986.1985.




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

  3Incorporated by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended November 30, 1989.

  4Incorporated by reference to Exhibits to the Registrant’s Registration Statement on Form S-3 filed August 27, 1991.

  5Incorporated by reference to Exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 1985.

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

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

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

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

1110         Incorporated by reference to Exhibits to the Registrant’s Registration Statement on Form S-3 filed December 10, 1997.

1211         Incorporated by reference to Exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 1999.

1312         Incorporated by reference to Exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 2000.

14Incorporated by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended August 31, 2001.

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

1613         Incorporated by reference to Exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 2001.




1714         Incorporated by reference to Exhibits to the Registrant’s AnnualQuarterly Report on Form 10-K10-Q for the fiscal yearquarter ended May 31, 2002.November 30, 2001.

1815         Incorporated by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended February 28, 2003.

1916         Incorporated by reference to Exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 2003.

20Incorporated by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended August 31, 2003.

2117         Incorporated by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended November 30, 2003.

2218         Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated February 3, 2004.

2319         Incorporated by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended February 29, 2004.

2420         Incorporated by reference to Exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended May 31, 2004.

2521         Incorporated by reference to Exhibits to the Registrant’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, 2004.2005.

2624         Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated October 21, 2004.24, 2005.

2725         Incorporated by reference to Exhibits to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended November 30, 2005.

26         Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated November 30, 2004.January 26, 2006.

2827         Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated December 20, 2004.February 1, 2006.

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

29Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated March 29, 2005.May 31, 2006.

30Incorporated 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.

33Incorporated by reference to Exhibits to the Registrant’s Current Report on Form 8-K dated July 15, 2005.12, 2007.