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AAR Corporation 10-Q 2012
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
For the Quarterly Period Ended February 29, 2012
or
For the transition period from to
Commission File No. 1-6263
AAR CORP. (Exact name of registrant as specified in its charter)
(630) 227-2000 (Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
As of February 29, 2012, there were 40,287,771 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 29, 2012
PART I — FINANCIAL INFORMATION
AAR CORP. and Subsidiaries Condensed Consolidated Balance Sheets As of February 29, 2012 and May 31, 2011 (In thousands)
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
AAR CORP. and Subsidiaries Condensed Consolidated Balance Sheets As of February 29, 2012 and May 31, 2011 (In thousands)
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
AAR CORP. and Subsidiaries Condensed Consolidated Statements of Income For the Three and Nine Months Ended February 29/28, 2012 and 2011 (Unaudited) (In thousands, except per share data)
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
AAR CORP. and Subsidiaries Condensed Consolidated Statements of Cash Flows For the Nine Months Ended February 29/28, 2012 and 2011 (Unaudited) (In thousands)
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
AAR CORP. and Subsidiaries Condensed Consolidated Statement of Changes in Equity For the Nine Months Ended February 29, 2012 (Unaudited) (In thousands)
The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
Note 1 — Basis of Presentation
AAR CORP. and its subsidiaries are referred to herein collectively as “AAR,” “Company,” “we,” “us,” and “our,” unless the context indicates otherwise. The accompanying condensed consolidated financial statements include the accounts of AAR and its subsidiaries after elimination of intercompany accounts and transactions.
We have prepared these statements without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”). The condensed consolidated balance sheet as of May 31, 2011 has been derived from audited financial statements. To prepare the financial statements in conformity with U.S. generally accepted accounting principles, management has made a number of estimates and assumptions relating to the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Certain information and note disclosures, normally included in comprehensive financial statements prepared in accordance with U.S. generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations of the SEC. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our latest annual report on Form 10-K.
In the opinion of management, the condensed consolidated financial statements reflect all adjustments (which consist only of normal recurring adjustments) necessary to present fairly the condensed consolidated financial position of AAR CORP. and its subsidiaries as of February 29, 2012, the condensed consolidated statements of income for the three- and nine-month periods ended February 29, 2012 and February 28, 2011, its cash flows for the nine-month periods ended February 29, 2012 and February 28, 2011 and the condensed consolidated statement of changes in equity for the nine-month period ended February 29, 2012. The results of operations for such interim periods are not necessarily indicative of the results for the full year.
Beginning with our third quarter of fiscal 2012, we are no longer treating the operating results of our Amsterdam component repair business as a discontinued operation. During the period, we made the decision to retain the operation after considering the results of our sales process and reviewing strategic alternatives for the business. The operating results for the Amsterdam business have been reported in continuing operations for all periods presented and are not material to our financial position or results of operations.
Note 2 — Revenue Recognition
Sales and related cost of sales for product sales are recognized upon shipment of the product to the customer. Our standard terms and conditions provide that title passes to the customer when the product is shipped to the customer. Sales of certain defense products are recognized upon customer acceptance, which includes transfer of title. Under the majority of our expeditionary airlift services contracts, we are paid and record as revenue a fixed daily amount per aircraft for each day an aircraft is available to perform airlift services. In addition, we are paid and record as revenue an amount which is based on number of hours flown. Sales from services and the related cost of services are generally recognized when customer-owned material is shipped back to the customer. We have adopted this accounting policy because at the time the customer-owned material is shipped back to the customer, all services related to that material are complete as our service agreements generally do not require us to provide services at customer sites. Furthermore, serviced units are typically shipped to the customer immediately upon completion of the related services. Sales and related cost of sales for certain long-term manufacturing contracts and certain large airframe maintenance contracts and performance-based logistics programs are recognized by the percentage of completion method, either based on the relationship of costs incurred to date to estimated
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
total costs or the 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.
Included in accounts receivable as of February 29, 2012 and May 31, 2011, are $35,771 and $28,867, respectively, of unbilled accounts receivable related to a defense supply chain support agreement. These unbilled accounts receivable relate to costs we have incurred on parts that were requested and accepted by our customer to support the program. These costs have not been billed by us because the customer has not issued the final paperwork necessary to allow for billing.
In addition to the unbilled accounts receivable, included in Other on the condensed consolidated balance sheet as of February 29, 2012 and May 31, 2011, are $33,684 and $19,404, respectively, of costs in excess of amounts billed for the same defense supply chain support agreement. We expect to recover costs in excess of amounts billed through future billings over the life of the program.
Note 3 — Accounting for Stock-Based Compensation
We provide stock-based awards under the AAR CORP. Stock Benefit Plan (“Stock Benefit Plan”) which has been approved by our stockholders. Under the Stock Benefit Plan, we are authorized to issue stock options to employees and non-employee directors that allow the grant recipients to purchase shares of common stock at a price not less than the fair market value of the common stock on the date of grant. Generally, stock options awarded expire ten years from the date of grant and are exercisable in three, four or five equal annual increments commencing one year after the date of grant. We issue common stock upon the exercise of stock options. In addition to stock options, the Stock Benefit Plan also provides for the grant of restricted stock awards and performance-based restricted stock awards. The number of performance-based awards earned, subject to vesting, is based on achievement of certain Company-wide financial goals or stock price targets. The Stock Benefit Plan also provides for the grant of stock appreciation units and restricted stock units; however, to date, no such awards have been granted.
We measure share-based compensation based on the fair value of the award at the grant date, and recognize the cost of share-based awards over the applicable service period, which is generally the vesting period. Performance-based restricted stock compensation is recognized over the applicable service period and based on the level of achievement that is considered probable.
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
During the nine-month periods ended February 29, 2012 and February 28, 2011, we granted stock options representing 162,281 shares and 720,970 shares, respectively.
The weighted average fair value of stock options granted during the nine-month periods ended February 29, 2012 and February 28, 2011 was $11.64 and $8.06, 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:
The following table summarizes stock option activity for the nine-month period ended February 29, 2012:
The total fair value of stock options that vested during the nine-month periods ended February 29, 2012 and February 28, 2011 was $3,827 and $2,275, respectively. The total intrinsic value of stock options exercised during the nine-month periods ended February 29, 2012 and February 28, 2011 was $3,339 and $898, respectively. The tax benefit realized from stock options exercised during the nine-month periods ended February 29, 2012 and February 28, 2011 was $533 and $146, respectively. Expense charged to operations for stock options during the three-month periods ended February 29, 2012 and February 28, 2011 was $1,078 and $1,177, respectively. Expense charged to operations for stock options during the nine-month periods ended February 29, 2012 and February 28, 2011 was $3,279 and $3,222, respectively. As of February 29, 2012, we had $4,924 of unearned compensation related to stock options that will be amortized over an average remaining period of 1.0 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 29, 2012 and February 28, 2011 was $2,711 and $2,462, respectively. Amortization expense related to restricted stock awards during the nine-month periods ended February 29, 2012 and February 28, 2011 was $6,635 and $6,245, respectively.
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
Restricted share activity during the nine-month period ended February 29, 2012 was as follows:
During the nine-month period ended February 29, 2012, we granted a total of 45,000 restricted shares to members of the Board of Directors. As of February 29, 2012 we had $19,577 of unearned compensation related to restricted shares that will be amortized to expense over a weighted average period of 2.3 years.
Note 4 — Inventory
The summary of inventories is as follows:
Note 5 — Supplemental Cash Flow Information
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
Note 6 — Comprehensive Income
A summary of the components of comprehensive income is as follows:
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
Note 7 — Financing Arrangements
A summary of our recourse and non-recourse debt is as follows:
On January 23, 2012 we completed an offering of $175,000 aggregate principal amount of 7.25% Senior Notes due 2022 (the “Notes”). The Notes were sold to qualified institutional buyers in accordance with Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), and outside the United States to non-U.S. persons in accordance with Regulation S under the Securities Act. The Notes were sold at a price equal to 98.268% if the principal amount thereof, for a yield to maturity of 7.5%. The
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
net proceeds of the offering of the Notes were used to repay a portion of the borrowings under our revolving credit agreement incurred to fund our December 2011 acquisition of Telair® International GmbH and Nordisk Aviation Products AS from Teleflex Incorporated.
The Notes are governed by an Indenture dated as of January 23, 2012 (the “Indenture”) by and among AAR, certain subsidiary guarantors identified therein (the “Guarantors”) and U.S. Bank National Association, as trustee.
The Notes bear interest at a rate of 7.25% per year, payable semi-annually, in cash in arrears, on January 15 and July 15 of each year, commencing July 15, 2012. The Notes will mature on January 15, 2022. Prior to January 15, 2015, AAR may redeem up to 35% of the aggregate principal amount of the Notes with the net cash proceeds of certain equity offerings at a redemption price of 107.25% of the principal amount thereof, plus accrued and unpaid interest and additional interest, if any, to the redemption date. At any time prior to January 15, 2017, AAR may redeem the Notes, in whole or in part, at a redemption price equal to 100% of the principal amount of the Notes redeemed, plus a make-whole premium, plus any accrued and unpaid interest and additional interest, if any, to the redemption date. AAR may redeem the Notes at its option, in whole or in part, at any time on or after January 15, 2017, upon not less than 30 nor more than 60 days’ notice at the redemption prices (expressed as percentages of the principal amount to be redeemed) set forth below, plus any accrued and unpaid interest and additional interest, if any, to the redemption date if redeemed during the 12-month period beginning on January 15 of the years indicated below:
The Notes are unconditionally guaranteed, on a full, joint and several basis, by each of the Guarantors, which consist of all of our existing domestic subsidiaries. The Notes and the guarantees are general unsecured senior obligations of AAR and the Guarantors, respectively, rank equally in right of payment with all existing and future senior debt of AAR and the Guarantors, as applicable, and are senior in right of payment to all future subordinated obligations of AAR or the Guarantors. The Notes and the guarantees are effectively subordinated to secured debt of AAR and the Guarantors, respectively, to the extent of the value of the assets securing that debt. In addition, the Notes are structurally junior to any debt or other liabilities of our nonguarantor subsidiaries.
The Indenture contains covenants that, amount other things, limit AAR’s and its Restricted Subsidiaries’ (as defined in the Indenture) abilities to (i) incur additional debt or sell preferred stock, (ii) pay dividends, redeem or repurchase stock or make other distributions, (iii) make certain investments, (iv) make other restricted payments and investments, (v) agree to or allow to exist restrictions on the ability to pay dividends or make other payments on its capital interests, (vi) create liens without granting equal and ratable liens to the holders of the Notes, (vii) enter into sale and leaseback transactions, (viii) merge, consolidate or transfer or dispose of substantially all of their assets, (ix) enter into certain types of transactions with affiliates and (x) sell assets. These covenants are subject to a number of qualifications and limitations. In addition, the Indenture limits AAR’s and the Restricted Subsidiaries’ abilities to engage in businesses other than businesses in which such companies are engaged on the date of issuance of the Notes and related businesses.
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
On April 12, 2011, we entered into an agreement with various financial institutions, as lenders and Bank of America, N.A., as administrative agent for the lenders (as amended, the “Credit Agreement”) providing for an unsecured revolving credit facility that we can draw upon for general corporate purposes. The revolving commitment was originally $400,000 and on October 13, 2011 was increased to $580,000. Under certain circumstances, we may request an increase to the revolving commitment by an aggregate amount of up to $100,000, not to exceed $680,000 in total. The Credit Agreement expires on April 12, 2016. Borrowings under the Credit Agreement bear interest at the offered Eurodollar Rate (defined as the British Bankers Association LIBOR Rate) plus 125 to 225 basis points based on certain financial measurements if a Eurodollar Rate loan, or at the offered fluctuating Base Rate plus 25 to 125 basis points based on certain financial measurements if a Base Rate loan.
During the second quarter of fiscal 2012, we sold an aircraft and the associated non-recourse debt of $3,252, which was due April 3, 2015, was assumed by the purchaser. Also during the second quarter of fiscal 2012, we purchased our joint venture partner’s interest in a narrow-body aircraft. In connection with this acquisition, we assumed $6,545 of non-recourse debt, which was paid in full on December 8, 2011.
During the first quarter of fiscal 2012, the non-recourse note due July 19, 2012 became fully recourse to the Company and is presented in the recourse portion of the table above.
During the nine-month period ended February 28, 2011, we repurchased $6,000 par value of our 2.25% convertible notes due March 1, 2016. The notes were repurchased for $4,667 cash, and the gain of $97, after consideration of unamortized discount and debt issuance costs, is recorded in Gain on extinguishment of debt on the condensed consolidated statements of income.
At February 29, 2012, the face value of our long-term recourse debt was $628,720 and the estimated fair value was approximately $627,000. The fair value of the Company’s long-term recourse debt is classified as Level 2 in the fair value hierarchy. Level 2 refers to fair values estimated using significant other observable inputs including quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
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.
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
As of February 29, 2012 and May 31, 2011, the long-term debt and equity component (recorded in capital surplus, net of income tax benefit) consisted of the following:
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 29, 2012 and February 28, 2011, 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:
Subsequent Event
On March 9, 2012, we entered into a five (5) year full amortization term loan agreement with Development Bank of Japan Inc. (the “Loan Agreement”) under which we intend to borrow $50,000 on an unsecured basis to refinance indebtedness incurred to finance the acquisition of Telair and Nordisk. Borrowings under the Loan Agreement bear interest at the offered Eurodollar Rate (defined as the British Bankers Association LIBOR Rate) plus 250 basis points.
The Loan Agreement in part requires us to comply with certain financial covenants which are consistent with our Credit Agreement. The Loan Agreement is not guaranteed by the Company’s subsidiaries. The Loan Agreement also contains certain affirmative and negative covenants, including those relating to financial reporting and notification, payment of indebtedness, taxes and other obligations, compliance with applicable laws, and limitations on additional liens, indebtedness, acquisitions, investments and disposition of assets.
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
Note 8 — Derivative Instruments and Hedging Activities
We are exposed to interest rate risk associated with fluctuations in interest rates on our variable rate debt. During the first quarter of fiscal 2012, we entered into two derivative financial instruments in order to manage our variable interest rate exposure over a medium- to long-term period. In June, we entered into a floating-to-fixed interest rate swap to hedge interest on $50,000 of notional principal balance under our revolving credit agreement. Also in June, we entered into an interest rate cap agreement on $50,000 of notional principal interest under our revolving credit agreement.
We do not hold or issue derivative instruments for trading purposes and are not a party to any instruments with leverage or prepayment features. In connection with derivative financial instruments, there exists the risk of the possible inability of counterparties to meet the terms of their contracts. We mitigate this risk by performing financial reviews before the contract is entered into, as well as on-going periodic evaluations. We do not expect any significant losses from counterparty defaults.
We classify the derivatives as assets or liabilities on the balance sheet. Accounting for the change in fair value of the derivatives is a function of whether the instrument qualifies for, and has been designated as, a hedging relationship, and the type of hedging relationship. As of February 29, 2012, all of our derivative instruments were classified as cash flow hedges. The fair value of the interest rate swap and interest cap agreements represents the difference in the present values of cash flows calculated at the contracted interest rates and at current market interest rates at the end of the reporting period.
The fair value of the Company’s interest rate derivatives are classified as Level 2 in the fair value hierarchy. At February 29, 2012, the fair value of the Company’s interest rate derivatives was recorded as follows:
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
We include gains and losses on the derivative instruments in other comprehensive income. We recognize the gains and losses on our derivative instruments as an adjustment to interest expense in the period the hedged interest payment affects earnings. The impact of the interest rate swap and interest cap agreement on the condensed consolidated statement of income for the three- and nine-month periods ended February 29, 2012 was as follows:
We expect minimal gain or loss to be reclassified into earnings within the next 12 months.
Note 9 — Earnings per Share
The computation of basic earnings per share is based on the weighted average number of common shares outstanding during each period. The computation of diluted earnings per share is based on the weighted average number of common shares outstanding during the period plus, when their effect is dilutive, incremental shares consisting of shares subject to stock options, shares issuable upon vesting of restricted stock awards and shares to be issued upon conversion of convertible debt.
We use the “if-converted” method in calculating the diluted earnings per share effect of the assumed conversion of our contingently convertible debt issued in fiscal 2006 because the principal for that issuance can be settled in stock, cash or a combination thereof. Under the “if converted” method, the after-tax effect of interest expense related to the convertible securities is added back to net income, and the convertible debt is assumed to have been converted into common shares at the beginning of the period.
In accordance with ASC 260-10-45, Share-Based Payment Arrangements and Participating Securities and the Two-Class Method, the Company’s unvested restricted stock awards are deemed participating securities since these shares are entitled to participate in dividends declared on common shares. During periods of net income, the calculation of earnings per share for common stock exclude income attributable to unvested restricted stock awards from the numerator and exclude the dilutive impact of those shares from the denominator. During periods of net loss, no effect is given to the participating securities because they do not share in the losses of the Company.
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (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 29, 2012 and February 28, 2011.
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
At February 29, 2012 and February 28, 2011, respectively, stock options to purchase 260,000 and 278,000 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 10 — Acquisitions
On December 2, 2011, we acquired Telair® International GmbH (“Telair”) and Nordisk Aviation Products, AS (“Nordisk”). Telair is a leader in the design, manufacture and support of cargo loading systems for wide-body and narrow-body aircraft with established positions on the world’s most popular current and next-generation passenger and freighter aircraft. Telair operates from facilities in Germany, Sweden and Singapore. Nordisk designs and manufactures heavy duty pallets and lightweight cargo containers for commercial airlines from facilities in Norway and China. The purchase price of the acquisition was approximately $293,000. The businesses operate as part of our Structures and Systems segment.
On October 11, 2011, we acquired Airinmar Holdings Limited (“Airinmar”), an international provider of aircraft component repair management services. Airinmar operates as part of our Aviation Supply Chain segment. Total consideration is estimated to be $43,500, which includes $23,200 cash paid at closing, and a potential earn-out payment of $20,300. The potential earn-out payment is based upon Airinmar achieving certain EBITDA (earnings before interest, taxes, depreciation and amortization) levels over a two-year period, as well as retaining certain key customers. In accordance with accounting principles generally accepted in the United States of America, a liability of $20,300 was recognized as an estimate of the acquisition date fair value of the earn-out and is included in Other non-current liabilities on our condensed consolidated balance sheet as of February 29, 2012. Any change in the fair value of the earn-out subsequent to the date of acquisition will be recognized in earnings.
We are continuing our review of our fair value estimate of assets acquired and liabilities assumed during the measurement period, which will conclude as soon as we receive the information we are seeking about facts and circumstances that existed as of the acquisition date, or learn that more information is not available. This measurement period will not exceed one year from the acquisition date. At the effective date of the acquisition, the assets acquired and liabilities assumed are generally required to be measured at fair value.
Our fair value estimate of assets acquired and liabilities assumed is pending completion of several elements, including the finalization of an independent appraisal and valuations of fair value of the assets acquired and liabilities assumed and final review by our management. The primary areas that are not yet finalized relate to the fair value of accounts receivable, accounts payable, inventories, property and equipment, intangible assets, favorable or unfavorable contracts, operating leases or commitments, contingent liabilities and income and non-income related taxes. Accordingly, there could be material adjustments to our consolidated financial statements, including changes in our depreciation and amortization expense related to the valuation of property and equipment and intangible assets acquired and their respective useful lives among other adjustments.
The final determination of the assets acquired and liabilities assumed will be based on the established fair value of the assets acquired and the liabilities assumed as of the acquisition date. The excess of the purchase price over the fair value of net assets acquired is allocated to goodwill. The final determination of the purchase price, fair values and resulting goodwill may differ significantly from what is reflected in these condensed consolidated financial statements.
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
The preliminary purchase price allocation for Telair, Nordisk and Airinmar follows:
The following unaudited pro forma information is provided for acquisitions assuming the Telair, Nordisk and Airinmar acquisitions occurred as of the beginning of fiscal 2011.
Note 11 —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 29, 2012, the Company had ownership interests in 19 aircraft with joint venture partners. As of February 29, 2012, our equity investment in the 19 aircraft owned with joint venture partners was approximately $37,008 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
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
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 29, 2012 and 2011, we were paid $500 and $635, 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:
Wholly-Owned Aircraft
In addition to the aircraft owned with joint venture partners, we own three aircraft for our own account that are considered wholly-owned. Our investment in the three wholly-owned aircraft, after consideration of financing, is comprised of the following components:
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
Information relating to aircraft type, year of manufacture, lessee, lease expiration date and expected disposition upon lease expiration for the 19 aircraft owned with joint venture partners and three wholly-owned aircraft is as follows:
Aircraft Owned through Joint Ventures
(1) 6 aircraft in 2012; 4 aircraft in 2013 and 4 aircraft in 2014
Wholly-Owned Aircraft
Note 12 — 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.
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.
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 requirements for a
AAR CORP. and Subsidiaries Notes to Condensed Consolidated Financial Statements February 29, 2012 (Unaudited) (Dollars in thousands, except per share amounts)
mobile and agile force, 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, 2011. 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:
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