AAR (AIR) 10-Q 2011 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended February 28, 2011

or

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

For the transition period from                     to                    

Commission File No. 1-6263

AAR CORP.

(Exact name of registrant as specified in its charter)

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	60191
(Address of principal executive offices)	(Zip Code)

(630) 227-2000

(Registrant’s telephone number, including area code)

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

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

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

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

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

As of February 28, 2011, there were 39,739,031 shares of the registrant’s Common Stock, $1.00 par value per share, outstanding.

AAR CORP. and Subsidiaries

Quarterly Report on Form 10-Q

For the Quarter Ended February 28, 2011

Table of Contents

			Page
Part I — FINANCIAL INFORMATION
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets	3-4
		Condensed Consolidated Statements of Income	5
		Condensed Consolidated Statements of Cash Flows	6
		Condensed Consolidated Statement of Changes in Equity	7
		Notes to Condensed Consolidated Financial Statements	8-19
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20-26
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
	Item 4.	Controls and Procedures	26
Part II — OTHER INFORMATION
	Item 1A.	Risk Factors	27
	Item 6.	Exhibits	27
	Signature Page		28
	Exhibit Index		29

2

PART I — FINANCIAL INFORMATION

Item 1 — Financial Statements

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of February 28, 2011 and May 31, 2010

(In thousands)

	February 28,		May 31,
	2011		2010
	(Unaudited)
Assets:
Current assets:
Cash and cash equivalents	$	54,716	$	79,370
Accounts receivable, less allowances of $4,491 and $4,773, respectively	300,030		238,466
Inventories	385,436		370,282
Rotable spares and equipment on or available for short-term lease	138,028		126,622
Deposits, prepaids and other	28,134		27,194
Deferred tax assets	21,495		21,495
Total current assets	927,839		863,429
Property, plant and equipment, net of accumulated depreciation of $224,393 and $194,139, respectively	318,857		224,866
Other assets:
Goodwill and other intangible assets, net	159,055		169,253
Equipment on long-term lease	101,813		109,564
Investment in joint ventures	47,274		48,433
Other	101,153		85,497
	409,295		412,747
	$	1,655,991	$	1,501,042

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

3

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of February 28, 2011 and May 31, 2010

(In thousands)

	February 28,			May 31,
	2011			2010
	(Unaudited)
Liabilities and equity:
Current liabilities:
Short-term debt	$	60,000		$	45,009
Current maturities of long-term debt	53,295			53,292
Current maturities of non-recourse long-term debt	806			757
Current maturities of long-term capital lease obligations	1,891			1,775
Accounts and trade notes payable	200,656			114,906
Accrued liabilities	102,534			109,811
Total current liabilities	419,182			325,550
Long-term debt, less current maturities	313,671			317,594
Non-recourse debt	11,244			11,855
Capital lease obligations	5,291			6,742
Deferred tax liabilities	69,127			57,335
Other liabilities and deferred income	32,880			35,616
	432,213			429,142
Equity:
Preferred stock, $1.00 par value, authorized 250 shares; none issued	—			—
Common stock, $1.00 par value, authorized 100,000 shares; issued 44,989 and 44,870 shares, respectively	44,989			44,870
Capital surplus	421,308			416,842
Retained earnings	467,693			419,287
Treasury stock, 5,247 and 5,386 shares at cost, respectively	(101,281		)	(104,447		)
Accumulated other comprehensive loss	(27,557		)	(29,646		)
Total AAR shareholders’ equity	805,152			746,906
Noncontrolling interest	(556		)	(556		)
Total equity	804,596			746,350
	$	1,655,991		$	1,501,042

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

4

AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Income

For the Three and Nine Months Ended February 28, 2011 and 2010

(Unaudited)

(In thousands, except per share data)

	Three Months Ended						Nine Months Ended
	February 28,						February 28,
	2011			2010			2011			2010
Sales:
Sales from products	$	308,349		$	243,815		$	903,058		$	771,196
Sales from services	142,682			57,030			392,888			180,411
	451,031			300,845			1,295,946			951,607
Costs and operating expenses:
Cost of products	265,435			201,002			772,026			647,581
Cost of services	107,823			41,627			302,468			130,421
Selling, general and administrative	42,527			34,091			124,643			105,121
	415,785			276,720			1,199,137			883,123
Earnings from joint ventures	56			56			2,613			150
Operating income	35,302			24,181			99,422			68,634
Gain on extinguishment of debt	—			—			97			913
Interest expense	(7,595		)	(6,523		)	(22,607		)	(19,541		)
Interest income	62			146			298			752
Loss on investment	—			(1,876		)	—			(1,876		)
Income from continuing operations before provision for income taxes	27,769			15,928			77,210			48,882
Provision for income taxes	9,465			5,381			26,769			15,360
Income from continuing operations	18,304			10,547			50,441			33,522
Discontinued operations, net of tax	(386		)	(762		)	(2,035		)	(1,386		)
Net income attributable to AAR and noncontrolling interest	17,918			9,785			48,406			32,136
Loss attributable to noncontrolling interest	—			127			—			1,292
Net income attributable to AAR	$	17,918		$	9,912		$	48,406		$	33,428
Earnings per share — basic:
Earnings from continuing operations	$	0.48		$	0.28		$	1.32		$	0.91
Loss from discontinued operations	(0.01		)	(0.02		)	(0.06		)	(0.03		)
Earnings per share — basic	$	0.47		$	0.26		$	1.26		$	0.88
Earnings per share — diluted:
Earnings from continuing operations	$	0.45		$	0.28		$	1.26		$	0.90
Loss from discontinued operations	(0.01		)	(0.02		)	(0.05		)	(0.03		)
Earnings per share — diluted	$	0.44		$	0.26		$	1.21		$	0.87
Weighted average common shares outstanding — basic	38,361			38,217			38,341			38,154
Weighted average common shares outstanding — diluted	43,713			43,108			43,458			42,921

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

5

AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

For the Nine Months Ended February, 2011 and 2010

(Unaudited)

(In thousands)

	Nine Months Ended
	February 28,
	2011			2010
Cash flows from operating activities:
Net income attributable to AAR and noncontrolling interest	$	48,406		$	32,136
Adjustments to reconcile net income attributable to AAR and noncontrolling interest to net cash provided from operating activities:
Depreciation and amortization	43,163			26,609
Amortization of debt discount	9,150			8,699
Stock-based compensation	9,467			6,270
Deferred tax provision	12,340			(5,560		)
Tax benefits from exercise of stock options	(146		)	(223		)
Gain on extinguishment of debt	(97		)	(913		)
Loss on investment	—			1,876
Earnings from joint ventures	(2,613		)	(150		)
Changes in certain assets and liabilities:
Accounts and notes receivable	(56,142		)	22,159
Inventories	(14,981		)	15,599
Rotable spares and equipment on or available for short-term lease	(11,605		)	16,329
Equipment on long-term lease	2,063			4,962
Accounts payable	43,052			(6,789		)
Accrued and other liabilities	(8,205		)	(15,987		)
Other, primarily deposits and program costs	(13,950		)	(10,370		)
Net cash provided from operating activities	59,902			94,647
Cash flows from investing activities:
Property, plant and equipment expenditures	(82,354		)	(20,749		)
Proceeds from disposal of assets	21			84
Proceeds from sale of business	—			650
Proceeds from sale of available for sale securities	—			434
Proceeds from aircraft joint ventures	5,042			37
Investment in aircraft joint ventures	(4,795		)	(4,198		)
Proceeds from leveraged leases	—			5,220
Other	(1,441		)	(1,575		)
Net cash used in investing activities	(83,527		)	(20,097		)
Cash flows from financing activities:
Change in short-term borrowings, net	14,991			103
Reduction in borrowings	(13,466		)	(70,204		)
Reduction in capital lease obligations	(1,334		)	(1,382		)
Reduction in equity due to convertible bond repurchases	(236		)	(254		)
Purchase of treasury stock	(2,539		)	—
Stock option exercises	1,385			1,614
Tax benefits from exercise of stock options	146			223
Contributions from noncontrolling interest	—			462
Net cash used in financing activities	(1,053		)	(69,438		)
Effect of exchange rate changes on cash	24			(91		)
Increase (decrease) in cash and cash equivalents	(24,654		)	5,021
Cash and cash equivalents, beginning of period	79,370			112,505
Cash and cash equivalents, end of period	$	54,716		$	117,526

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

6

AAR CORP. and Subsidiaries

Condensed Consolidated Statement of Changes in Equity

For the Nine Months Ended February 28, 2011

(Unaudited)

(In thousands)

										Accumulated
										Other			Total AAR
	Common		Capital		Retained		Treasury			Comprehensive			Shareholders’			Noncontrolling			Total
	Stock		Surplus		Earnings		Stock			Income (Loss)			Equity			Interest			Equity
Balance, May 31, 2010	$	44,870	$	416,842	$	419,287	$	(104,447	)	$	(29,646	)	$	746,906		$	(556	)	$	746,350
Net income	—		—		48,406		—			—			48,406			—			48,406
Exercise of stock options and stock awards	1		2,913		—		671			—			3,585			—			3,585
Tax benefit related to share-based plans	—		146		—		—			—			146			—			146
Restricted stock activity	118		957		—		5,171			—			6,246			—			6,246
Repurchase of shares	—		—		—		(2,539		)	—			(2,539		)	—			(2,539		)
Bond hedge and warrant activity	—		137		—		(137		)	—			—			—			—
Equity portion of bond repurchase	—		313		—		—			—			313			—			313
Foreign currency translation gain	—		—		—		—			2,089			2,089			—			2,089
Balance, February 28, 2011	$	44,989	$	421,308	$	467,693	$	(101,281	)	$	(27,557	)	$	805,152		$	(556	)	$	804,596

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

7

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 1 — Basis of Presentation

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

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

In the opinion of management, the condensed consolidated financial statements reflect all adjustments (which consist only of normal recurring adjustments) necessary to present fairly the condensed consolidated financial position of AAR CORP. and its subsidiaries as of February 28, 2011, the condensed consolidated statements of income for the three- and nine-month periods ended February 28, 2011 and 2010, its cash flows for the nine-month periods ended February 28, 2011 and 2010 and the condensed consolidated statement of changes in equity for the nine-month period ended February 28, 2011.  The results of operations for such interim periods are not necessarily indicative of the results for the full year.

During the third quarter of fiscal 2011, we received $2,000 of relocation assistance from the State of Florida relating to the relocation of AAR Airlift. Net relocation expense during the period after taking into consideration the relocation assistance was approximately $1,600.

Note 2 — Accounting for Stock-Based Compensation

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

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

During the nine-month periods ended February 28, 2011 and 2010, we granted stock options representing 720,970 shares and 687,000 shares, respectively.

8

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

The weighted average fair value of stock options granted during the nine-month periods ended February 28, 2011 and 2010 was $8.06 and $7.40, respectively. The fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

	Nine Months Ended
	February 28,
	2011		2010
Risk-free interest rate	1.8	%	2.3	%
Expected volatility of common stock	47.0	%	49.2	%
Dividend yield	0.0	%	0.0	%
Expected option term in years	5.8		6.0

The following table summarizes stock option activity for the nine-month period ended February 28, 2011:

					Weighted
			Weighted		Average
	Number of		Average		Remaining	Aggregate
	Options		Exercise		Contractual	Intrinsic
	(in thousands)		Price		Life (years)	Value
Outstanding at May 31, 2010	1,543		$	19.28
Granted	721		$	17.54
Exercised	(88	)	$	15.72
Cancelled	(126	)	$	22.27
Outstanding at February 28, 2011	2,050		$	18.53	7.9	$	20,454
Exercisable at February 28, 2011	761		$	19.81	4.0	$	7,332

The total fair value of stock options that vested during the nine-month periods ended February 28, 2011 and 2010 was $2,275 and $690, respectively.  The total intrinsic value of stock options exercised during the nine-month periods ended February 28, 2011 and 2010 was $898 and $1,963, respectively.  The tax benefit realized from stock options exercised during the nine-month periods ended February 28, 2011 and 2010 was $146 and $223, respectively.  Expense charged to operations for stock options during the three-month periods ended February 28, 2011 and 2010 was $1,177 and $619, respectively.  Expense charged to operations for stock options during the nine-month periods ended February 28, 2011 and 2010 was $3,222 and $1,646, respectively.  As of February 28, 2011, we had $7,916 of unearned compensation related to stock options that will be amortized over an average remaining period of 2.0 years.

The fair value of restricted stock awards is the market value of our common stock on the date of grant.  Amortization expense related to restricted stock awards during the three-month periods ended February 28, 2011 and 2010 was $2,462 and $1,648, respectively.  Amortization expense related to restricted stock awards during the nine-month periods ended February 28, 2011 and 2010 was $6,245 and $4,624, respectively.

9

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

Restricted share activity during the nine-month period ended February 28, 2011 is as follows:

	Number of		Weighted Average
	Shares		Fair Value
	(in thousands)		on Grant Date
Unvested at May 31, 2010	1,205		$	23.93
Granted	404		$	17.40
Vested	(216	)	$	17.76
Forfeited	(18	)	$	18.99
Unvested at February 28, 2011	1,375		$	23.07

During the nine-month period ended February 28, 2011, we granted a total of 38,000 restricted shares to members of the Board of Directors.  As of February 28, 2011 we had $13,975 of unearned compensation related to restricted shares that will be amortized to expense over a weighted average period of 2.3 years.

Stock Repurchase Authorization

On June 20, 2006 our Board of Directors authorized us to purchase up to 1,500,000 shares of our common stock on the open market.  During the nine-month period ended February 28, 2011, we purchased 150,000 shares of our common stock on the open market at an average price of $16.92, leaving 1,028,300 shares still available for repurchase.

Note 3 — Inventory

The summary of inventories is as follows:

	February 28,		May 31,
	2011		2010
Raw materials and parts	$	65,671	$	62,737
Work-in-process	61,977		51,523
Purchased aircraft, parts, engines and components held for sale	257,788		256,022
	$	385,436	$	370,282

Note 4 — Supplemental Cash Flow Information

	Nine Months Ended
	February 28,
	2011		2010
Interest paid	$	11,117	$	10,517
Income taxes paid	9,074		22,153
Income tax refunds received	3,876		441

10

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 5 — Comprehensive Income

A summary of the components of comprehensive income (loss) is as follows:

	Three Months Ended					Nine Months Ended
	February 28,					February 28,
	2011		2010			2011		2010
Net income attributable to AAR and noncontrolling interest	$	17,918	$	9,785		$	48,406	$	32,136
Other comprehensive income (loss) —
Cumulative translation adjustments	1,007		(1,741		)	2,089		(357		)
Unrealized gain on investment, net of tax	—		297			—		—
Total comprehensive income	$	18,925	$	8,341		$	50,495	$	31,779

11

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 6 — Financing Arrangements

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

	February 28,			May 31,
	2011			2010
Recourse debt
Notes payable due May 15, 2011 with interest at 8.39% payable semi-annually on June 1 and December 1	$	42,000		$	42,000
Note payable due July 19, 2012 with interest at 7.22%, payable monthly	2,716			4,116
Note payable due May 1, 2015 with interest at 3.5%, payable monthly	57,262			64,225
Mortgage loan (secured by Wood Dale, Illinois facility) due August 1, 2015 with interest at 5.01%	11,000			11,000
Convertible notes payable due March 1, 2014 with interest at 1.625% payable semi-annually on March 1 and September 1	72,531			69,957
Convertible notes payable due March 1, 2016 with interest at 2.25% payable semi-annually on March 1 and September 1	50,737			53,652
Convertible notes payable due February 1, 2026 with interest at 1.75% payable semi-annually on February 1 and August 1	105,720			100,828
Industrial revenue bond (secured by trust indenture on property, plant and equipment) due August 1, 2018 with floating interest rate, payable monthly	25,000			25,108
Total recourse debt	366,966			370,886
Current maturities of recourse debt	(53,295		)	(53,292		)
Long-term recourse debt	$	313,671		$	317,594
Non-recourse debt
Non-recourse note payable due July 19, 2012 with interest at 7.22%	$	8,201		$	8,201
Non-recourse note payable due April 3, 2015 with interest at 8.38%	3,849			4,411
Total non-recourse debt	12,050			12,612
Current maturities of non-recourse debt	(806		)	(757		)
Long-term non-recourse debt	$	11,244		$	11,855

During the nine-month period ended February 28, 2011, we retired $6,000 par value of our 2.25% convertible notes due March 1, 2016.  The notes were retired for $4,667 cash, and the gain of $97, after consideration of unamortized discount and debt issuance costs, is recorded in gain on extinguishment of debt on the condensed consolidated statements of income.

During the nine-month period ended February 28, 2010, we retired $10,500 par value of our 1.625% convertible notes due March 1, 2014 and $2,000 par value of our 2.25% convertible notes due March 1, 2016.  Collectively, the convertible notes were retired for $9,115 cash, and the gain of $913, after consideration of unamortized discount and debt issuance costs, is recorded in gain on extinguishment of debt on the condensed consolidated statements of income.

12

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

At February 28, 2011, the face value of our long-term recourse debt was $406,359 and the estimated fair value was approximately $422,000.  The fair value was estimated using available market information.

Convertible Notes

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

As of February 28, 2011 and May 31, 2010, the long-term debt and equity component (recorded in capital surplus, net of income tax benefit) consisted of the following:

	February 28,			May 31,
	2011			2010
Long-term debt:
Principal amount	$	268,380		$	274,380
Unamortized discount	(39,392		)	(49,943		)
Net carrying amount	$	228,988		$	224,437
Equity component, net of tax	$	74,966		$	74,653

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

As of February 28, 2011 and 2010, for each of our convertible note issuances, the “if converted” value does not exceed its principal amount.

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

	Three Months Ended				Nine Months Ended
	February 28,				February 28,
	2011		2010		2011		2010
Coupon interest	$	1,229	$	1,273	$	3,704	$	3,833
Amortization of deferred financing fees	189		193		566		582
Amortization of discount	3,098		2,944		9,149		8,699
Interest expense related to convertible notes	$	4,516	$	4,410	$	13,419	$	13,114

13

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 7 — Earnings per Share

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

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

14

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

The following table provides a reconciliation of the computations of basic and diluted earnings per share information for the three- and nine-month periods ended February 28, 2011 and 2010.

	Three Months Ended						Nine Months Ended
	February 28,						February 28,
	2011			2010			2011			2010
Income from continuing operations	$	18,304		$	10,547		$	50,441		$	33,522
Loss from discontinued operations, net of tax	(386		)	(762		)	(2,035		)	(1,386		)
Loss attributable to noncontrolling interest	—			127			—			1,292
Net income attributable to AAR	$	17,918		$	9,912		$	48,406		$	33,428
Basic shares:
Weighted average common shares outstanding	38,361			38,217			38,341			38,154
Earnings per share — basic:
Earnings from continuing operations	$	0.48		$	0.28		$	1.32		$	0.91
Loss from discontinued operations, net of tax	(0.01		)	(0.02		)	(0.06		)	(0.03		)
Earnings per share — basic	$	0.47		$	0.26		$	1.26		$	0.88
Income from continuing operations	$	18,304		$	10,547		$	50,441		$	33,522
Add: Loss attributable to noncontrolling interest	—			127			—			1,292
Add: After-tax interest on convertible debt	1,415			1,328			4,178			3,924
Net income for diluted EPS calculation	$	19,719		$	12,002		$	54,619		$	38,738
Diluted shares:
Weighted average common shares outstanding	38,361			38,217			38,341			38,154
Additional shares from the assumed exercise of stock options	496			265			283			174
Additional shares from the assumed vesting of restricted stock	788			558			766			525
Additional shares from the assumed conversion of convertible debt	4,068			4,068			4,068			4,068
Weighted average common shares outstanding — diluted	43,713			43,108			43,458			42,921
Earnings per share — diluted:
Earnings from continuing operations	$	0.45		$	0.28		$	1.26		$	0.90
Loss from discontinued operations, net of tax	(0.01		)	(0.02		)	(0.05		)	(0.03		)
Earnings per share — basic	$	0.44		$	0.26		$	1.21		$	0.87

15

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

At February 28, 2011 and 2010, respectively, stock options to purchase 278,000 and 381,000 shares of common stock were outstanding, but were not included in the computation of diluted earnings per share because the exercise price of each of these options was greater than the average market price of the common shares during the interim periods then ended.

Note 8 —Aircraft Portfolio

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

Aircraft Owned through Joint Ventures

As of February 28, 2011, the Company had ownership interests in 24 aircraft with joint venture partners.  As of February 28, 2011, our equity investment in the 24 aircraft owned with joint venture partners was approximately $37,910 and is included in investment in joint ventures on the Condensed Consolidated Balance Sheet.  Our aircraft joint ventures represent investments in limited liability companies that are accounted for under the equity method of accounting.  Our membership interest in each of these limited liability companies is 50% and the primary business of these companies is the acquisition, ownership, lease and disposition of certain commercial aircraft.  Aircraft are purchased with cash contributions by the members of the companies and debt financing provided to the limited liability companies on a limited recourse basis.  Under the terms of servicing agreements with certain of the limited liability companies, we provide administrative services and technical advisory services, including aircraft evaluations, oversight and logistical support of the maintenance process and records management.  We also provide remarketing services with respect to the divestiture of aircraft by the limited liability companies.  For the nine-month periods ended February 28, 2011 and 2010, we were paid $635 and $580, respectively, for such services.  The income tax benefit or expense related to the operations of the ventures is recorded by the member companies.

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

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

	Three Months Ended				Nine Months Ended
	February 28,				February 28,
	2011		2010		2011		2010
Sales	$	10,484	$	11,411	$	48,339	$	33,845
Income before provision for income taxes	290		312		5,792		840

	February 28,		May 31,
	2011		2010
Balance sheet information:
Assets	$	231,102	$	259,965
Debt	141,676		167,255
Members’ capital	86,767		89,449

16

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

Wholly-Owned Aircraft

In addition to the aircraft owned with joint venture partners, we own five aircraft for our own account. A former lessee of two of our wholly-owned aircraft is in arrears for amounts due under the leases. We have obtained a judgment against the lessee and its affiliated guarantor and expect to recover past due rental amounts. Our net investments in these two aircraft after consideration of debt financing are $8,805 and $5,988, respectively. Our investment in the five wholly-owned aircraft, after consideration of financing, is comprised of the following components:

	February 28,			May 31,
	2011			2010
Gross carrying value	$	49,855		$	50,854
Debt	(14,767		)	(16,728		)
Capital lease obligation	(7,174		)	(8,492		)
Net AAR investment	$	27,914		$	25,634

Information relating to aircraft type, year of manufacture, lessee, lease expiration date and expected disposition upon lease expiration for the 24 aircraft owned with joint venture partners and five wholly-owned aircraft is as follows:

Aircraft owned with joint venture partners

		Year		Lease Expiration	Post-Lease
Quantity	Aircraft Type	Manufactured	Lessee	Date (FY)	Disposition
1	737-300	1987	US Airways	2012	Re-lease/Disassemble
2	767-300	1991	United Airlines	2016 and 2017	Re-lease
1	747-400	1989	Delta Airlines	2020	Re-lease/Disassemble
1	737-300	1997	Small Planet Airlines	2013	Re-lease
1	A320	1992	Air Canada	2015	Disassemble
18	737-400	1992-1997	Malaysia Airlines	Various(1)	Re-lease
24

Wholly-owned aircraft

		Year		Lease Expiration	Post-Lease
Quantity	Aircraft Type	Manufactured	Lessee	Date (FY)	Disposition
1	MD83	1989	Meridiana	2012	Sale/Re-lease
2	A320	1992, 1997	Available	—	Re-lease
1	A320	1992	Air Canada	2015	Re-lease
1	CRJ 200	1999	Air Wisconsin	2017	Sale/Disassemble
5

(1)  10 aircraft in 2012; 4 aircraft in 2013 and 4 aircraft in 2014

17

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 9 — Acquisitions

On April 7, 2010, we acquired Aviation Worldwide Services, a leading provider of expeditionary airlift services and aircraft modifications to the United States and other government customers.  The purchase price was approximately $200,000 and was paid in cash.  We have made a preliminary purchase price allocation for the acquisition and expect to complete the purchase price allocation by the end of March 2011.

Note 10 — Discontinued Operations

During the third quarter of fiscal 2011, we decided to exit our Amsterdam component repair facility, a business which was reported in our Aviation Supply Chain segment.  We are currently evaluating a number of strategic alternatives associated with the business unit, including the sale of the unit.  The aggregate carrying value of the unit is approximately $10,000 and we expect to recover the carrying value.

Revenues and pre-tax operating loss for the three- and nine-month periods ended February 28, 2011 and 2010 for the discontinued operation are summarized as follows:

	Three Months Ended						Nine Months Ended
	February 28,						February 28,
	2011			2010			2011			2010
Revenues	$	7,004		$	8,761		$	21,340		$	28,206
Pre-tax operating loss	(595		)	(1,172		)	(3,131		)	(2,133		)

Note 11 — Business Segment Information

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

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

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

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

18

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2011

(Unaudited)

(Dollars in thousands, except per share amounts)

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

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

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

	Three Months Ended				Nine Months Ended
	February 28,				February 28,
	2011		2010		2011		2010
Sales:
Aviation Supply Chain	$	112,962	$	81,129	$	324,552	$	274,480
Government and Defense Services	147,329		38,362		411,065		114,434
Maintenance, Repair and Overhaul	108,037		70,657		283,897		221,679
Structures and Systems	82,703		110,697		276,432		341,014
	$	451,031	$	300,845	$	1,295,946	$	951,607

	Three Months Ended				Nine Months Ended
	February 28,				February 28,
	2011		2010		2011		2010
Gross profit:
Aviation Supply Chain	$	19,778	$	14,866	$	58,358	$	50,187
Government and Defense Services	25,665		9,205		72,816		25,360
Maintenance, Repair and Overhaul	17,137		8,483		39,534		27,599
Structures and Systems	15,193		25,662		50,744		70,459
	$	77,773	$	58,216	$	221,452	$	173,605

19

AAR CORP. and Subsidiaries

February 28, 2011

Item 2 — 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; Government and Defense Services; Maintenance, Repair and Overhaul; and Structures and Systems. The table below sets forth consolidated sales for our four business segments for the three- and nine-month periods ended February 28, 2011 and 2010.

	Three Months Ended				Nine Months Ended
	February 28,				February 28,
	2011		2010		2011		2010
Sales:
Aviation Supply Chain	$	112,962	$	81,129	$	324,552	$	274,480
Government and Defense Services	147,329		38,362		411,065		114,434
Maintenance, Repair and Overhaul	108,037		70,657		283,897		221,679
Structures and Systems	82,703		110,697		276,432		341,014
	$	451,031	$	300,845	$	1,295,946	$	951,607

Over the last several quarters, many commercial airlines have reported increased revenues and profits, along with improving aircraft fleet capacity and utilization rates.  The improved commercial airline environment in large part correlates with the improving U.S. economy, which emerged from a deep recession in late 2009.  Beginning with our first quarter of fiscal 2011 ended August 31, 2010, we began to see the early signs of a recovery in demand for the products and services we offer our commercial customers.  This recovery gained momentum during our third quarter, as we experienced a 43.8% year-over-year increase in sales to commercial customers, representing 49.2% of consolidated sales for the three-months ended February 28, 2011.

We expect many carriers will continue to seek ways to reduce their cost structure, including outsourcing more of their maintenance and support functions to third parties, while we believe other carriers who have historically outsourced their maintenance requirements will continue to do so.  We believe we remain well-positioned to respond to the commercial market with our broad range of products and services.

During the third quarter of fiscal 2011, sales to global government and defense customers increased 56.4% compared to prior year and for the three-months ended February 28, 2011 represented 50.8% of consolidated sales.  The increase was largely driven by sales attributable to Aviation Worldwide Services, now known as Airlift Group, Inc. (“Airlift”), which the Company acquired on April 7, 2010.  Although our airlift business today contracts only with the U.S. Department of Defense, we are targeting other U.S. governmental agencies, as we believe our airlift services will be in greater demand as the U.S. broadens its interest in non-military activities, including nation building.

20

Results of Operations

Three-Month Period Ended February 28, 2011

Consolidated sales for the third quarter ended February 28, 2011 increased $150,186 or 49.9% compared to the prior year period.  Sales to commercial customers increased 43.8% compared to the prior year due to strong demand for supply chain and MRO services, while sales to government and defense customers increased 56.4% reflecting the inclusion of Airlift and increased sales at the Company’s defense logistics business.

In the Aviation Supply Chain segment, sales increased $31,833 or 39.2% compared to the prior year as our parts supply businesses benefitted from the improved airline environment and increased market share at certain customers.  Gross profit in the Aviation Supply Chain segment increased $4,912 or 33.0% and the gross profit margin percentage decreased to 17.5% from 18.3% in the prior year due to the mix of products sold.

In the Government and Defense Services segment, sales increased $108,967 or 284.0% compared to the prior year.  The sales increase reflects the inclusion of revenue from Airlift which contributed $73,083 of revenue during the third quarter, as well as growth in program business at the Company’s defense logistics business.  Gross profit increased $16,460 or 178.8% and the gross profit margin percentage declined to 17.4% from 24.0% in the prior year reflecting lower margins in the defense logistics business due to transition costs associated with a new performance-based logistics program and a contract adjustment which lowered the pricing for services we deliver under another supply chain program.

In the Maintenance, Repair and Overhaul segment, sales increased $37,380 or 52.9% versus the prior year due to strong sales growth at our engineering services business as well as at our heavy maintenance and landing gear facilities reflecting performance on contract awards announced in the previous twelve months and the improved airline environment.  Gross profit increased $8,654 or 102.0%, and the gross profit margin percentage increased to 15.9% from 12.0% in the prior year primarily due to increased volume and mix.

In the Structures and Systems segment, sales decreased $27,994 or 25.3% over the prior year due to the expected decline in the volume at our mobility products business.  Gross profit in the Structures and Systems segment decreased $10,469 or 40.8% and the gross profit margin percentage decreased to 18.4% from 23.2% in the prior year due to the mix of products sold and lower volume.

Operating income increased $11,121 or 46.0% compared with the prior year due to the increase in sales.  Selling, general and administrative expenses increased $8,436 or 24.7% reflecting the inclusion of selling, general and administrative expenses of Airlift including approximately $1,600 of relocation expenses, net of government relocation grants.  Earnings from aircraft joint ventures were flat compared to the prior year.  Net interest expense increased $1,156 or 18.1% compared to the prior year primarily due to an increase in outstanding borrowings.  Our effective income tax rate increased slightly to 34.1% in the third quarter of fiscal 2011 compared to 33.8% last year.

During the third quarter of fiscal 2011, we decided to exit our Amsterdam component repair facility, a business which was reported in our Aviation Supply Chain segment (see Note 10 of Notes to Condensed Consolidated Financial Statements).

Net income attributable to AAR was $17,918 compared to $9,912 in the prior year due to the factors discussed above.

21

Nine-Month Period Ended February 28, 2011

Consolidated sales for the nine-months ended February 28, 2011 increased $344,339 or 36.2% compared to the prior year period.  Sales to commercial customers increased 24.2% compared to the prior year due to increased demand for supply chain and MRO and engineering services, while sales to government and defense customers increased 49.2% reflecting the inclusion of Airlift and increased sales at the Company’s defense logistics business.

In the Aviation Supply Chain segment, sales increased $50,072 or 18.2% compared to the prior year as our parts supply businesses benefitted from the improved airline environment and recent investments in high demand products.  Prior year sales included a $5,329 sale of an interest in an aircraft leveraged lease.  Gross profit in the Aviation Supply Chain segment increased $8,171 or 16.3% and the gross profit margin percentage declined slightly to 18.0% from 18.3% in the prior year due to the mix of products sold.  Prior year gross profit was negatively impacted by the sale of the interest in a leveraged lease, in which the Company recorded a $3,800 negative gross profit margin.

In the Government and Defense Services segment, sales increased $296,631 or 259.2% compared to the prior year.  The sales increase reflects the inclusion of revenue from Airlift which contributed $205,012 of revenue during the first nine months of fiscal 2011, as well as growth in the Company’s defense logistics business due to the ramp-up of a new performance-based logistics program.  Gross profit increased $47,456 or 187.1% and the gross profit margin percentage declined to 17.7% from 22.2% in the prior year reflecting lower margins in the defense logistics business due to transition costs associated with the new performance-based logistics program and a contract adjustment which lowered the pricing for services we deliver under another supply chain program.

In the Maintenance, Repair and Overhaul segment, sales increased $62,218 or 28.1% versus the prior year due to strong sales growth at our heavy maintenance and landing gear facilities as well as at our engineering services business reflecting performance on contract awards announced in the previous twelve months and the improved airline environment.  Gross profit increased $11,935 or 43.2% due to increased volume and the gross profit margin percentage increased to 13.9% from 12.4% in the prior year due to increased volume and favorable mix.

In the Structures and Systems segment, sales decreased $64,582 or 18.9% over the prior year due to the expected decline in the volume of our mobility products business.  Gross profit in the Structures and Systems segment decreased $19,715 or 28.0% and the gross profit margin percentage decreased to 18.4% from 20.7% in the prior year due to the mix of products sold and lower volume.

Operating income increased $30,788 or 44.9% compared with the prior year due to the increase in sales.  Selling, general and administrative expenses increased $19,522 or 18.6% reflecting the inclusion of selling, general and administrative expenses of Airlift.  Earnings from aircraft joint ventures increased $2,463 compared to the prior year due to an aircraft sale from our joint venture aircraft portfolio during the second quarter.  Net interest expense increased $3,520 or 18.7% compared to the prior year primarily due to an increase in outstanding borrowings.  Our effective income tax rate increased to 34.7% compared to 31.4% last year, as the prior year rate reflected a favorable tax impact from the sale of the interest in the aircraft leveraged lease discussed above.

During the nine months ended February 28, 2011, we retired $6,000 par value of our 2.25% convertible notes resulting in a net gain on extinguishment of debt of $97.

During the third quarter of fiscal 2011, we decided to exit our Amsterdam component repair facility, a business which was reported in our Aviation Supply Chain segment (see Note 10 of Notes to Condensed Consolidated Financial Statements).

Net income attributable to AAR was $48,406 compared to $33,428 in the prior year due to the factors discussed above.

22

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 current capital resources include our unsecured revolving credit agreement.  We regularly evaluate various financing arrangements, including the issuance of common stock or debt, which would allow us to improve our liquidity position and finance future growth on commercially reasonable terms. 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 the overall health of the credit markets, general economic conditions, airline industry conditions, geo-political events, and our operating performance.  Our ability to generate cash from operations is influenced primarily by our operating performance and changes in working capital. Under a universal shelf registration statement filed with the Securities and Exchange Commission that became effective on December 12, 2008, we may offer and sell up to $300,000 of various types of securities, including common stock, preferred stock and medium-term or long-term debt securities, subject to market conditions.

At February 28, 2011, our liquidity and capital resources included cash of $54,716 and working capital of $508,657.  Our revolving credit agreement, as amended (the “Credit Agreement”) with various financial institutions, as lenders, and Bank of America National Association as successor by merger to LaSalle Bank National Association (“Bank of America”), as administrative agent for the lenders, provides us with unsecured revolving borrowing capacity of up to $250,000.  Under certain circumstances, we may request an increase to the revolving commitment by an aggregate amount of up to $75,000, not to exceed $325,000 in total.   The term of our Credit Agreement extends to August 31, 2011, and we are currently in discussions with our lenders regarding renewal and expansion of our Credit Agreement.  Borrowings under the Credit Agreement bear interest at the London Interbank Offered Rate (“LIBOR”) plus 100 to 237.5 basis points based on certain financial measurements.  Borrowings outstanding under this facility at February 28, 2011 were $60,000, and there were approximately $10,468 of outstanding letters of credit which reduced the availability of this facility.  In addition to our Credit Agreement, we also have $3,472 available under a foreign line of credit.

During the nine-month period ended February 28, 2011, cash flow from operations was $59,902 primarily as a result of net income attributable to AAR and noncontrolling interest and depreciation and amortization of $100,719, partially offset by a net increase in certain assets and liabilities of $59,768, primarily due to an increase in accounts receivable and investments in inventory and equipment on or available for short-term lease to support growth initiatives in several of the Company’s business units.

During the nine-month period ended February 28, 2011, our investing activities used $83,527 of cash principally as a result of capital expenditures of $82,354, which mainly represents helicopters and other equipment purchased to support growth and improve operating performance in our Government and Defense Services segment.

During the nine-month period ended February 28, 2011, our financing activities used $1,053 of cash primarily due to a reduction in borrowings of $13,466 and the purchase of treasury stock for $2,539, partially offset by an increase in short-term borrowings of $14,991.

23

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 those related to the allowance for doubtful accounts, assumptions used in assessing goodwill impairment, adjustments to reduce the value of inventories and aviation equipment on or available for lease, revenue recognition, loss accruals for aviation equipment operating leases, program development costs 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 our customer’s current and expected future financial performance.

Goodwill and Other Intangible Assets

Under accounting standards for 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. The Company reviews and evaluates its goodwill and indefinite life intangible assets for potential impairment at a minimum annually, on May 31, or more frequently if circumstances indicate that impairment is possible. We use a two step process to evaluate goodwill for impairment.  In the first step, we compare the fair value of each reporting unit with the carrying value of the reporting unit, including goodwill.  We estimate the fair value of each reporting unit using a valuation technique based on a multiple of earnings or discounted cash flows.  If the estimated fair value of the reporting unit is less than the carrying value of the reporting unit, we would be required to complete a second step to determine the amount of goodwill impairment.  In the second step, we would determine an implied fair value of the reporting unit’s goodwill by allocating the reporting unit’s fair value to all of the assets and liabilities other than goodwill.  We then would compare the implied fair value of goodwill to the carrying amount and recognize the difference as an impairment charge.

The assumptions we used to estimate the fair value of our reporting units are based on historical performance as well as forecasts used in our current business plan.

The amount reported under the caption “Goodwill and other intangible assets, net” is comprised of goodwill and intangible assets associated with acquisitions we made, principally since the beginning of fiscal 1998.

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.  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 the recognition of impairment charges in future periods.

24

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.

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 accounting standards addressing impairment 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.

Program Development Costs

In June 2005, we announced that our Cargo Systems business was selected to provide cargo handling systems for the new Airbus A400M Military Transport Aircraft (“A400M”).  Our portion of the revenue from this program is expected to exceed $300,000 through fiscal 2020, based on sales projections of the A400M.  As of February 28, 2011, we have capitalized, net of reimbursements, approximately $59,200 of costs associated with the engineering and development of the cargo system.  Sales and related cost of sales will be recognized on the units of delivery method.  In determining the recoverability of the capitalized program development costs, we have utilized certain judgments and estimates concerning expected revenues and the cost to manufacture the A400M cargo system.  Differences between actual results and the assumptions utilized by us may result in us not fully recovering the value of the program development costs, which would unfavorably impact our financial condition and results of operations.

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, 2010, 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

25

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

Forward-Looking Statements

This report contains certain forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are based on beliefs of our 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 Part II, Item 1A under the heading “Risk Factors” and to those set forth under Part I, Item 1A in our Annual Report on Form 10-K for the year ended May 31, 2010.  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 update 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.

Item 3 — Quantitative and Qualitative Disclosures About Market Risk

There were no material changes to our market risk as set forth in Item 7A of our Annual Report on Form 10-K for the year ended May 31, 2010.

Item 4 — Controls and Procedures

As required by Rules 13a-15(e) and 15d-15(e) of the Exchange Act, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of February 28, 2011.  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 February 28, 2011.

There were no changes in our internal control over financial reporting during the third quarter ended February 28, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

26

PART II — OTHER INFORMATION

Item 1A — Risk Factors

There have been no material changes to our risk factors as set forth in our Annual Report on Form 10-K for the year ended May 31, 2010.

Item 6 — Exhibits

The exhibits to this report are listed on the Exhibit Index included elsewhere herein.  Management contracts and compensatory arrangements, if any, have been marked with an asterisk (*) on the Exhibit Index.

27

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		AAR CORP.
		(Registrant)
Date:	March 22, 2011	/s/ RICHARD J. POULTON
		Richard J. Poulton
		Vice President, Chief Financial Officer and Treasurer
		(Principal Financial Officer and officer duly authorized to sign on behalf of registrant)
		/s/ MICHAEL J. SHARP
		Michael J. Sharp
		Vice President, Controller and Chief Accounting Officer
		(Principal Accounting Officer)

28

EXHIBIT INDEX

Exhibit No.	Description		Exhibits
31.	Rule 13a-14(a)/15(d)-14(a) Certifications	31.1	Section 302 Certification dated March 22, 2011 of David P. Storch, Chairman and Chief Executive Officer of Registrant (filed herewith).
		31.2	Section 302 Certification dated March 22, 2011 of Richard J. Poulton, Vice President, Chief Financial Officer and Treasurer of Registrant (filed herewith).
32.	Section 1350 Certifications	32.1	Section 906 Certification dated March 22, 2011 of David P. Storch, Chairman and Chief Executive Officer of Registrant (filed herewith).
		32.2	Section 906 Certification dated March 22, 2011 of Richard J. Poulton, Vice President, Chief Financial Officer and Treasurer of Registrant (filed herewith).
101.	Interactive Data File	101	The following materials from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended February 28, 2011, formatted in XBRL (eXtensible Business Reporting Language): (i) Condensed Consolidated Balance Sheets at February 28, 2011 and May 31, 2010, (ii) Condensed Consolidated Statements of Income for the three and nine months ended February 28, 2011 and 2010, (iii) Condensed Consolidated Statements of Cash Flows for the nine months ended February 28, 2011 and 2010, (iv) Condensed Consolidated Statement of Changes in Equity for the nine months ended February 28, 2011 and (v) Notes to Condensed Consolidated Financial Statements.*

*  Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

29