AIR

AAR CORP. 10-Q Summary: Quarter Ended February 28, 2005

Business Context and Reporting Period

This filing is a Quarterly Report on Form 10-Q for AAR CORP., a provider of value-added products and services to the global aviation/aerospace industry. The report covers the three and nine-month periods ended February 28, 2005. The company operates through four segments: Inventory and Logistic Services, Maintenance, Repair and Overhaul (MRO), Manufacturing, and Aircraft and Engine Sales and Leasing.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Consolidated sales increased 24.2% ($38.5 million) for the quarter and 15.0% ($70.3 million) for the nine-month period compared to the prior year. Growth was driven by a 40.8% increase in sales to commercial airline customers and strong demand for defense mobility products.
• Profitability: Net income for the nine-month period surged to $9.7 million from $0.9 million in the prior year. This improvement was aided by a $1.6 million tax benefit related to the American Jobs Creation Act of 2004 and a $0.5 million gain on early debt retirement.
• Discontinued Operations: The company sold its engine component repair business in February 2005, recording a pre-tax loss on disposal of $3.5 million ($2.2 million after-tax). This resulted in a net loss from discontinued operations of $3.0 million for the nine-month period.
• Segment Performance: The Manufacturing segment saw a 41.4% sales increase year-over-year for the nine-month period. The Aircraft and Engine Sales and Leasing segment sales increased 94.8% due to the sale of aircraft interests.

Guidance, Outlook, and Risks

Management Commentary: Management attributes sales growth to improved passenger traffic and successful marketing efforts. Gross profit margins improved slightly to 15.9% for the nine-month period due to favorable product mix and operational efficiencies. The company expects continued strong sales to U.S. Military customers.

Liquidity and Capital: As of February 28, 2005, the company had $98.1 million in total liquidity (unrestricted cash plus available credit facilities). Non-recourse notes totaling $31.5 million mature in July 2005; management expects to refinance these on favorable terms.

Risks and Contingencies:

• Industry Conditions: Results may be adversely affected by airline industry restructurings, high fuel costs, and geopolitical events.
• Government Sales: Approximately 34.6% of sales for the nine-month period were to the U.S. Government; there is no assurance these levels will continue.
• Asset Impairment: The company maintains significant inventory and leased equipment. Future declines in market values or demand could necessitate additional impairment charges.
• Accounting Changes: Adoption of SFAS No. 123(R) in fiscal 2006 is expected to result in approximately $1.5 million of pre-tax compensation expense.

Investor Verification Checklist

• Refinancing Risk: Verify the status of the $31.5 million non-recourse debt maturing in July 2005 and the terms of the proposed refinancing.
• Discontinued Operations: Confirm the final settlement of the engine component repair business sale and any remaining liabilities.
• Inventory Valuation: Review the $199.3 million inventory balance for potential future impairment charges given the volatility in the aviation sector.
• Government Contract Exposure: Assess the sustainability of the 34.6% revenue reliance on U.S. Government contracts.
• Stock-Based Compensation: Monitor the impact of the upcoming SFAS No. 123(R) adoption on future earnings per share.