AIR

AAR CORP. 10-Q Summary: Quarter Ended August 31, 2007

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended August 31, 2007, for AAR CORP., a Delaware corporation. The company operates in four segments: Aviation Supply Chain, Maintenance, Repair and Overhaul (MRO), Structures and Systems, and Aircraft Sales and Leasing. As of September 30, 2007, there were 37,934,750 shares of common stock outstanding.

Key Financial Metrics

Note: All figures in thousands except per share data.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated sales increased 27.4% ($65.7 million) driven by growth across all four segments. The Aircraft Sales and Leasing segment saw the largest jump ($19.4 million) due to the sale of two aircraft.
• Profitability: Operating income rose 49.9% to $26.9 million. Net income increased 28.6% to $15.2 million.
• Segment Performance:
  • Aviation Supply Chain: Sales up 11.9%; Gross profit margin improved to 22.4% (from 17.5%) due to product mix and the absence of a $4.75 million impairment charge recorded in the prior year.
  • MRO: Sales up 26.3% due to Indianapolis operations and the Reebaire acquisition; gross margin declined slightly to 12.8% due to inefficiencies.
  • Structures and Systems: Sales up 31.0% driven by defense demand and the Brown International acquisition; gross margin declined to 11.9% due to lower shipments of high-margin containers.
• Cash Flow: Operating cash flow turned positive ($2.1 million) compared to a negative $1.9 million in the prior year, aided by reductions in receivables and inventory. However, investing activities consumed $40.0 million, primarily for aircraft joint venture investments ($22.1 million) and securities ($10.9 million).

Guidance, Outlook, and Risks

• Management Commentary: Management notes improved financial results for domestic airlines, driven by fare increases and cost controls. They anticipate continued outsourcing of maintenance functions by carriers. Defense demand remains strong, though the company is monitoring the debate regarding troop withdrawal from Iraq.
• Strategic Moves: The company exited its non-core industrial turbine business (classified as discontinued operations) and expects to sell it by February 29, 2008. It continues to build its aircraft portfolio through joint ventures (31 aircraft held as of Aug 31, 2007).
• Liquidity: On August 31, 2007, the company amended its credit agreement, increasing the unsecured revolving credit facility to $250 million (from $140 million) and extending the term to August 2011. No borrowings were outstanding under this facility at quarter-end.
• Risks: Risks include general economic conditions, airline industry volatility, geo-political events, and the ability to generate cash from operations. The company also faces potential future impairments on inventory and leased equipment if market conditions deteriorate.

Investor Verification Checklist

• Acquisition Integration: Verify the financial impact and integration progress of the Reebaire (Jan 2007) and Brown International (Apr 2007) acquisitions.
• Discontinued Operations: Confirm the timeline and expected proceeds for the sale of the industrial turbine business.
• Inventory Valuation: Review the $26.3 million in net impaired inventory and engines; assess the risk of further write-downs given high fuel costs and reduced operator demand.
• Joint Venture Exposure: Evaluate the $22.1 million investment in aircraft joint ventures and the associated leverage (debt of $253.8 million within the ventures).
• Debt Structure: Analyze the impact of the amended credit facility and the $12.9 million capital lease obligation from the recent sale-leaseback transaction.