ITEM 1. BUSINESS (IN THOUSANDS, EXCEPT PERCENTAGE AND EMPLOYEE DATA)
AAR CORP. and its subsidiaries are referred to herein collectively as "AAR" or the "Company," unless the context indicates otherwise. The Company was organized in 1955 as the successor to a business founded in 1951 and was reincorporated in Delaware in 1966. The Company is a worldwide leader in supplying aftermarket products and services to the global aviation/aerospace industry.
Certain of the Company's aviation-related activities and products are subject to licensing, certification and other requirements imposed by the Federal Aviation Administration (FAA) and other regulatory agencies, both domestic and foreign. The Company believes that it has all licenses and certifications that are material to the conduct of its business.
The Company reports its activities in one business segment: Aviation Services. Three classes of similar products and services are included within this segment: (i) Aircraft and Engines, (ii) Airframe and Accessories and (iii) Manufacturing.
The Company's Aircraft and Engines activities include (i) the purchase, sale, and lease of new and used commercial jet aircraft, (ii) the purchase, sale and lease of a wide variety of new, overhauled and repaired engines and engine products for the aviation aftermarket, including a broad range of spare engines and engine parts and other engine components and accessories, and (iii) the overhaul, repair and exchange of a wide range of engine parts and components and other engine support services for its commercial and military customers. The Company also provides customized inventory supply and management programs for engine parts and components in support of customer maintenance activities. The Company has two FAA licensed repair stations in the U.S. to perform engine component overhaul services which cover a broad range of internal engine parts and components. The Company also provides turbine engine overhaul and parts supply services to industrial gas and steam turbine operators. The Company's primary sources of aviation products for its Aircraft and Engine activities are domestic and foreign airlines, independent aviation service companies, aircraft leasing companies and original equipment manufacturers.
The Company's Airframe and Accessories activities consist of (i) the purchase, sale and lease of new, overhauled and repaired airframe parts and accessories for the aviation aftermarket, and (ii) a wide variety of airframe and accessory parts and components overhaul, as well as repair and exchange services for its commercial, military and general aviation customers. The Company also provides customized inventory supply and management programs for certain airframe parts and components in support of customer maintenance activities. The Company's primary sources of airframe parts for its Airframe and Accessories activities are domestic and foreign airlines, independent aviation service companies and aircraft leasing companies. The Company is also an authorized distributor for more than 200 leading aviation/aerospace product manufacturers.
The Company's Airframe and Accessories overhaul and repair capabilities include most commercial aircraft landing gear, a wide variety of avionics, instruments, electrical, electronic, fuel, hydraulic and pneumatic components and a broad range of internal airframe components. AAR also operates an aircraft maintenance facility providing maintenance, modification, special equipment installation, painting services and aircraft terminal services for various models of commercial, military, regional, business and general aviation aircraft. During fiscal 1999, the Company purchased the assets of Tempco Hydraulics, Inc., a regional aircraft landing gear repair and overhaul business. AAR's overhaul and repair of parts and components also support the sale, lease and inventory management activities of the Company. AAR has eight FAA-licensed repair stations in the U.S. and two in Europe to perform airframe/component overhaul services.
The Company's Manufacturing activities include (i) the design, manufacture and installation of in-plane cargo loading and handling systems for commercial and military aircraft and helicopters, (ii) the design and manufacture of advanced composite materials for commercial, business and military aircraft, (iii) the manufacture and repair of a wide array of containers, pallets and shelters in support of military and humanitarian rapid deployment activities, (iv) the design and manufacture of a line of specialized protective transport cases that are used to transport sensitive and calibrated tools and instruments, and a variety of vacuum storage containers that protect machinery and equipment during long-term storage. During fiscal 1999, the Company divested substantially all of its assets and related liabilities of its floor maintenance products manufacturing subsidiary.
The Company furnishes aviation products and services primarily through its own employees. The principal customers for the Company's products and services are domestic and foreign commercial airlines, regional/commuter airlines, business aircraft operators, aviation original equipment manufacturers, aircraft leasing companies, domestic and foreign military organizations and independent aviation support companies. Sales of aviation products and services to commercial airlines are generally affected by such factors as the number, type and average age of aircraft in service, the levels of aircraft utilization (e.g., frequency of schedules), the number of airline operators and the level of sales of new and used aircraft.
The Company is a leading independent supplier of aviation products and services to the highly competitive worldwide aviation/aerospace aftermarket. Competition is based on quality, ability to provide a broad range of products and services, speed of delivery and price. Competitors in the parts supply business include the original equipment manufacturers, commercial airlines, and other independent suppliers of parts and services. In certain of its leasing and commercial jet aircraft trading activities, the Company faces competition from financial institutions, syndicators, commercial and specialized leasing companies and other entities that provide financing. AAR also competes with various repair and overhaul organizations, which include the service arms of original equipment manufacturers, the maintenance departments or divisions of large commercial airlines (some of which also offer maintenance services to third parties) and independent organizations. AAR's pallet, container and shelter manufacturing activities compete with several modest-sized private companies, and its cargo systems competitors include a number of divisions of large corporations. Although certain of the Company's competitors have substantially greater financial and other resources than the Company, the Company believes that it has maintained a satisfactory competitive position through its responsiveness to customer needs, its attention to quality and its unique combination of trading expertise, technical capabilities and financial strength.
At May 31, 1999, backlog believed to be firm was approximately $83,600 compared to $107,400 at May 31, 1998. An additional $8,100 of unfunded government options on awarded contracts also existed at May 31, 1999. It is expected that approximately $82,100 of the May 31, 1999 backlog will be shipped in fiscal 2000.
Sales to the U.S. Government, its agencies and its contractors were approximately $98,954 (10.8 % of total net sales), $83,114 (10.6% of total net sales) and $82,125 (13.9% of total net sales) in fiscal years 1999, 1998 and 1997, respectively. Because such sales are subject to competitive bidding and government funding, no assurance can be given that such sales will continue at levels previously experienced. The majority of the Company's government contracts are for aviation products and services used for ongoing routine military logistic support activities; unlike weapons systems and other high-technology military requirements, these products and services are less likely to be affected by reductions in defense spending. The Company's contracts with the U.S. Government and its agencies are typically firm agreements to provide aviation products and services at a fixed price and have a term of one year or less, frequently subject to extension for one or more additional periods of one year at the option of the government agency. Although the Company's government contracts are subject to termination at the election of the government, in the event of such a termination the Company would be entitled to recover from the government all allowable costs incurred by the Company through the date of termination.
At May 31, 1999, the Company employed approximately 2,900 persons worldwide.
For additional information concerning the Company's business segment activities, including classes of similar products and services, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations." For information concerning export sales, see "Business Segment Information" in Note 11 of Notes to Consolidated Financial Statements.
ITEM 2.
ITEM 2. PROPERTIES
The Company's principal aircraft and engine sales and leasing activities as well as engine and airframe components and aftermarket parts distribution activities are conducted from one building, which is owned by the Company, in Wood Dale, Illinois. In addition to warehouse space, the facility includes executive and sales offices. The Company also owns and operates one building in Elk Grove Village, Illinois for the purpose of the distribution of new aviation parts. Warehouse facilities are leased in Windsor Locks, Connecticut; Hamburg and Hannover, Germany; Nantgarw, Wales; and Brussels, Belgium for the purpose of aviation parts distribution.
Aviation overhaul facilities are located in The Netherlands near Schiphol International Airport in a building owned by the Company; Garden City, New York in a building owned by the Company; Frankfort, New York (subject to an industrial revenue bond to the Company until 2001, at which time the Company expects to purchase the facility for nominal consideration); Windsor, Connecticut in a building owned by the Company; Miami, Florida in leased facilities; London, England in leased facilities, and Oklahoma City, Oklahoma in facilities leased from airport authorities. The Company's experience indicates that lease renewal is available on reasonable terms consistent with its business needs.
The Company's principal manufacturing activities are conducted at owned facilities in Clearwater, Florida (subject to an industrial revenue bond); Port Jervis, New York; and Cadillac and Livonia, Michigan.
The Company believes that its owned and lease facilities are suitable and adequate for its existing business.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material, pending legal proceedings (including any governmental or environmental proceedings) other than routine litigation incidental to its existing business.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.
SUPPLEMENTAL INFORMATION:
EXECUTIVE OFFICERS OF THE REGISTRANT
Information concerning each executive officer of the Company is set forth below:
MR. STORCH has been President of the Company since 1989 and Chief Executive Officer since 1996. Previously, he was Chief Operating Officer from 1989 to 1996 and a Vice President of the Company from 1988 to 1989. Mr. Storch joined the Company in 1979 and was President of a major subsidiary from 1984 to 1988. Mr. Storch has been a director of the Company since 1989. Mr. Storch is Mr. Eichner's son-in-law.
MR. EICHNER, the founder of the Company, has been Chairman of the Board of the Company since 1973, and an executive officer and director since it was founded in 1955. Mr. Eichner retired as an executive officer and active employee of the Company on May 31, 1999, and is continuing as a director and nonexecutive Chairman of the Board of the Company. Mr. Eichner was the Company's Chief Executive Officer from 1955 until 1996. Mr. Eichner is Mr. Storch's father-in-law.
At the July 1999 Board Meeting, the Board of Directors acknowledged the extraordinary contributions to AAR of Ira A. Eichner as he relinquished his role as an executive officer. As founder of the Company, Mr. Eichner's vision, foresight and leadership has resulted in growing AAR into a billion dollar New York Stock Exchange public company, recognized as the pre-eminent product and services provider in the aviation industry. His energetic dedication to the Company's success and to ensuring shareholder value has been unparalleled for more than 48 years. He brought diversity to the Company's capabilities and customer base through a series of strategic acquisitions, creating balance and synergies between its trading, overhaul and manufacturing businesses. He also set a standard of integrity, instilling it into the Company's culture for all employees to emulate.
In addition to leading AAR through good times and more difficult periods, achieving profitability every year since the Company's inception, Mr. Eichner emphasized the importance to the Company's future of prudent fiscal management and a strong balance sheet. He built an outstanding management team, paying special attention to successful management planning in order to provide for the Company's ongoing growth. The Board of Directors feel most fortunate that, as a continuing director and nonexecutive Chairman of the Board, Ira Eichner will give his guidance and counsel to the Company's management, sharing his wealth of experience.
MR. SLAPKE was elected Executive Vice President of the Company in 1999. From 1994 to 1999, he was a Vice President of the Company. He is also President of a major subsidiary, a position he has held since 1989, and has been with the Company in various positions since 1981.
MR. PULSIFER joined the Company as General Counsel in 1987 and has been a Vice President since 1989 and Secretary since 1990. He was previously with United Airlines, Inc. for 14 years, most recently as Senior Counsel.
MR. ROMENESKO has been a Vice President and Chief Financial Officer since 1994. Previously he served as Controller of the Company from 1991 to 1995 and in various other positions since joining the Company in 1981.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (IN THOUSANDS, EXCEPT PER SHARE INFORMATION, PERCENTAGE DATA AND NUMBER OF STOCKHOLDERS)
The Company's Common Stock is traded on the New York Stock Exchange and the Chicago Stock Exchange. On June 30, 1999, there were approximately 11,000 holders of the Common Stock of the Company, including participants in security position listings.
Certain of the Company's debt agreements contain provisions restricting the payment of dividends or repurchase of its shares. See Note 2 of Notes to Consolidated Financial Statements included herein. Under the most restrictive of these provisions, the Company may not pay dividends (other than stock dividends) or acquire its capital stock if, after giving effect to the aggregate amounts paid on or after June 1, 1996, such amounts exceed the sum of $25,000 plus 50% of Consolidated Net Income of the Company after June 1, 1996. At May 31, 1999, unrestricted consolidated retained earnings available for payment of dividends and purchase of the Company's shares totaled approximately $18,482. At June 1, 1999, unrestricted consolidated retained earnings increased to $39,318, due to inclusion of 50% of Consolidated Net Income of the Company for fiscal 1999.
The table below sets forth for each quarter of the fiscal year indicated the reported high and low market prices of the Company's Common Stock on the New York Stock Exchange and the quarterly dividends declared.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
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Notes:
(1) All share and per share information reflects the three-for-two stock split on February 23, 1998.
(2) In December 1997, the Company sold $60,000 of unsecured 6.875% Notes due December 15, 2007.
(3) In February 1997, the Company sold three million shares of its common stock for $50,075, net of expenses.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (IN THOUSANDS, EXCEPT PERCENTAGE DATA)
RESULTS OF OPERATIONS
The Company reports its activities in one business segment: Aviation Services. The table below sets forth net sales for the Company's classes of similar products and services within this segment for each of the last three fiscal years ended May 31.
THREE-YEAR NET SALES SUMMARY
Over the last three fiscal years, consolidated net sales increased as the Company successfully pursued opportunities in the aviation/aerospace market. The Company has broadened the range of products sold, created and maintained long-term strategic supply relationships with customers, and established industry-leading capabilities in inventory asset management programs. The Company has developed a customized portfolio of value-added products and services, such as Internet-based electronic commerce tools, to take advantage of changing market dynamics. Net sales growth during the three-year period also benefited from acquisitions of new-parts distribution and aircraft composites manufacturing businesses, as well as an overall growth in customer base. These factors, coupled with a sustained period of economic growth and profitability in the worldwide aviation/aerospace market, resulted in a net sales increase in all three of the Company's classes of similar products and services over the last three fiscal years.
The Company believes that its established global market position, its ability to respond to changes in the industry, including technological changes, and its diverse customer base, position the Company to take advantage of future opportunities in the aviation/aerospace market.*
* THIS SECTION CONTAINS FORWARD-LOOKING STATEMENTS WHICH ARE IDENTIFIED WITH AN ASTERISK (*). PLEASE SEE COMMENTS ON FORWARD-LOOKING STATEMENT RISK FACTORS IN THE "FORWARD-LOOKING STATEMENTS" SECTION ON PAGE 12 .
FISCAL 1999 COMPARED WITH FISCAL 1998
Consolidated net sales for fiscal 1999 increased 17.4% to $918.0 million from $782.1 million in fiscal 1998. This increase was attributable to continued strong demand for the Company's broad range of products and services and, among other things, full-year sales from businesses acquired in fiscal 1998. Aircraft and Engines sales increased $76,897 or 22.7% resulting from higher sales of engine parts, driven primarily from strength in inventory management programs, and increased aircraft sales and leasing revenues. These increases were partially offset by the impact of certain engine parts sales which were recorded by Turbine Engine Asset Management L.L.C. (an unconsolidated joint venture company) during fiscal 1999, but were recorded by Aircraft and Engines during the first half of fiscal 1998. Airframe and Accessories sales increased $42,976 or 12.9%, driven primarily by the impact of full-year sales from the new-parts distribution companies acquired during fiscal 1998, as well as increased demand for aircraft maintenance and landing gear overhaul repair capabilities. Manufacturing sales increased $16,040 or 14.6% due to increased sales of products supporting the U.S.Government's rapid deployment program, the inclusion of full-year sales from AAR Composites (acquired in fiscal 1998) and higher sales of cargo handling systems. These gains were partially offset by the unfavorable impact of the divestiture of the Company's floor maintenance products manufacturing subsidiary in November 1998.
Consolidated gross profit increased $24,853 or 16.7% due to increased consolidated net sales. The fiscal 1999 consolidated gross profit margin of 18.9% is slightly less than the consolidated gross profit margin of 19.0% of the prior year. Consolidated operating income increased $12,665 or 19.6% over the prior year on the strength of increased sales, partially offset by increased selling, general and administrative expenses. Selling, general and administrative expenses were lower as a percentage of consolidated net sales; however, total expenses increased due to the impact from companies acquired during fiscal 1998, as well as increased marketing support and information technology costs, which include Year 2000 compliance costs. Interest expense increased $4,073 or 28.1% over the prior year primarily due to the full-year effect of the $60 million of unsecured 6.875% Notes issued in December 1997.
Consolidated net income increased $6,014 or 16.9% over the prior year as a result of the above-noted factors.
FISCAL 1998 COMPARED WITH FISCAL 1997
Consolidated net sales increased $192,795 or 32.7% over the prior fiscal year, reflecting strong demand for the Company's broad range of products and services and the effect of acquisitions during fiscal 1998. Acquisitions, net of prior year dispositions, contributed $77,234 to the sales increase over the prior year. Aircraft and Engines sales increased $76,225 or 29.0%, resulting from higher sales in its engine and engine parts businesses, as well as increased aircraft sales. Airframe and Accessories sales increased $111,850 or 50.5%, driven primarily by sales from the new-parts distribution companies, which were acquired in fiscal 1998, and increased demand for the Company's aircraft maintenance and aircraft component overhaul and repair capabilities. Sales in Manufacturing increased $4,720 or 4.5%, reflecting increased cargo loading and handling system sales and the inclusion of sales from ATR (AAR Composites), which was acquired in October 1997, partially offset by lower sales from products supporting the U.S. Government's rapid deployment program.
Consolidated gross profit increased $39,865 or 36.7%, due to increased consolidated net sales and an increase in the consolidated gross profit margin to 19.0% from 18.4% in the prior year. The increase in the consolidated gross profit margin during fiscal 1998 reflected the favorable mix of inventories sold and improved margins in certain manufactured products.
Consolidated operating income increased $21,826 or 50.9% over the prior fiscal year as a result of the increase in net sales and the higher gross profit margin, partially offset by increased selling, general and administrative expenses. Selling, general and administrative expenses were lower as a percentage of consolidated net sales; however, total expenses increased principally due to the inclusion of recently acquired companies and increased personnel costs. Interest expense increased $3,708 or 34.4% over the prior year, principally due to the impact of the Company's sale of $60 million of unsecured 6.875% Notes in December 1997.
Consolidated net income increased $12,632 or 54.9% over the prior year as a result of the factors previously discussed.
FISCAL 1997 COMPARED WITH FISCAL 1996
The Company's operating results showed improvement over the prior fiscal year as it experienced higher demand for its products and services in a strong aviation/aerospace market. Consolidated net sales increased $84,338 or 16.7% over the prior fiscal year reflecting higher sales in the Company's Aircraft and Engines and Airframe and Accessories activities. Consolidated operating income increased $10,448 or 32.2% over the prior year due to increased consolidated net sales and a higher consolidated gross profit margin, partially offset by higher selling, general and administrative costs. Net income increased $7,013 or 43.8%, due to increased consolidated net sales and gross profit margin.
Aircraft and Engines sales increased $80,845 or 44.4% over the prior year due to growth in sales of engine parts and engine and aircraft sales and leasing products. Increased volume through the Company's long-term inventory management programs contributed to the sales increase in engine parts. Airframe and Accessories sales increased $18,550 or 9.1%, reflecting increased demand for certain aircraft and aircraft component repair and maintenance services and higher airframe parts sales. Sales in Manufacturing declined $15,057 or 12.6%, resulting from lower demand for products supporting the U.S. Government's rapid deployment program.
Consolidated gross profit increased $17,776 or 19.6%, due to increased consolidated net sales and an increase in the consolidated gross profit margin to 18.4% from 18.0% in the prior year. The increase in the consolidated gross profit margin during fiscal 1997 was attributable to the favorable mix of products and services sold through Aircraft and Engines and Airframe and Accessories activities, partially offset by lower margins on certain manufactured products due to lower sales volume.
Consolidated operating income increased $10,448 or 32.2% over the prior year as a result of the increase in consolidated net sales and the higher consolidated gross profit margin, partially offset by higher selling, general and administrative costs. The increase in selling, general and administrative costs was driven by increased personnel and marketing support costs.
Consolidated net income increased $7,013 or 43.8% over the prior year as a result of the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
At May 31, 1999, the Company's liquidity and capital resources included cash and cash equivalents of $8,250 and working capital of $334,600. At May 31, 1999, the Company's long-term debt-to-capitalization ratio was 35.7%, compared to 37.1% at May 31, 1998. The Company continues to maintain its external sources of financing with $178,800 of unused available bank lines and a shelf registration statement on file with the Securities and Exchange Commission under which up to $200 million of common stock, preferred stock or medium- or long-term debt securities may be issued or sold subject to market conditions.
During fiscal 1999, the Company generated $28,525 of cash from operations compared to $22,823 and $9,531 during fiscal 1998 and 1997, respectively. This was principally attributable to increased net income and improved working capital management.
During fiscal 1999, the Company's investing activities used $22,893 of cash primarily composed of $36,131 of property, plant and equipment expenditures reflecting the Company's continued investment in new information technology systems and facility expansions; a $6,000 payment made for the Tempco acquisition, which was acquired in October 1998; and a final payment of $9,175 for the acquisition of AVSCO, which was acquired in December 1997, offset by proceeds from the sale of equipment on long-term lease and cash received from the divestiture of the Company's floor maintenance products manufacturing subsidiary of $11,685.
During fiscal 1999, the Company's financing activities used $14,602 of cash, reflecting primarily the payment of cash dividends of $9,375 and the purchase of $7,558 of the Company's stock, offset by proceeds of an industrial revenue bond of $2,300.
The Company believes that its cash and cash equivalents and available sources of capital will continue to provide the Company with the ability to meet its ongoing working capital requirements, make anticipated capital expenditures, meet contractual commitments and pay dividends.*
A summary of key indicators of financial condition and lines of credit follows:
YEAR 2000
During fiscal 1997, the Company initiated a comprehensive information technology systems review which resulted in a formal plan to replace and enhance certain of the Company's business application systems to meet current operational requirements and provide for future expansion. These replacement systems are Year 2000 compliant and include new information technology systems in the Company's new-parts distribution business, all of the Company's manufacturing facilities and three of the Company's overhaul facilities.
During the third quarter of fiscal 1999, the Company successfully completed the implementation of the replacement systems at its manufacturing facilities. During March 1999, the Company successfully completed the implementation of the replacement system in its new-parts distribution business. The capital outlay associated with the successful implementation of the replacement systems in the manufacturing and new-parts distribution businesses was $8,700, of which $7,600 was paid during the twelve-month period ended May 31, 1999.
The Company has expanded and modified its plans to replace the existing systems at its overhaul facilities to include, among other things, purchasing new hardware, upgrading the main existing operating system and converting the existing business application to ensure Year 2000 compliance. The Company believes that the cost of the new hardware and the cost to upgrade the existing operating system to provide for Year 2000 compliance for the overhaul businesses' current systems will be approximately $1,000.* Additional enhancements, which include the implementation of the new systems, may continue into the Year 2000, although the Company anticipates that the business applications supporting the three overhaul facilities will be Year 2000 compliant by October 1999.*
In addition to the above, the Company has conducted an extensive Year 2000 compliance review of its internal systems which are not being replaced. Based on this study and program testing, the Company believes that the business applications supporting the Company's trading businesses and certain other overhaul businesses are Year 2000 compliant.* In addition, the Company believes that its existing major financial applications are Year 2000 compliant, although the Company is in the process of upgrading its major financial applications to the most recent version.*
In addition to the cost of the business application systems being implemented or enhanced to meet operational requirements, the Company expects to incur other Year 2000 compliance costs unrelated to the replacement systems referenced above. The Company has numerous local-area networks, wide-area networks, servers, voice mail systems and other technical support systems (the "sub-systems"). The Company has completed an inventory of the sub-systems, as well as the compliance status of the sub-systems, and believes that approximately 95% of the sub-systems are Year 2000 compliant.* The Company expects the remaining sub-systems will be Year 2000 compliant by September 30, 1999 at a cost of less than $100.*
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* See "Forward Looking Statements" section of this item.
YEAR 2000 (CONTINUED)
As part of its continuing review, the Company has communicated with its material vendors, customers and suppliers regarding their Year 2000 compliance. While the Company is aggressively addressing the Year 2000 issue internally, the compliance status of third parties with which the Company has material relationships is presently unknown and the failure of third parties to be compliant could potentially have an adverse effect on the Company's operations.* The Company believes that the Year 2000 compliance failure of a significant third-party supplier or customer is the most reasonably likely worst case scenario for a Year 2000 failure.* As compliance risks become known for significant third parties, contingency plans will be developed accordingly.
FORWARD-LOOKING STATEMENTS
Management's Discussion and Analysis of Financial Condition and Results of Operations contains certain statements relating to future results, which are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995 and are identified by an asterisk(*). These forward-looking statements are based on beliefs of Company management, as well as assumptions and estimates based on information currently available to the Company, 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: integration of acquisitions; marketplace competition; implementation of Year 2000 compliant information technology systems and system enhancements; unidentified Year 2000 problems; failure of a third-party supplier, service provider or customer to be Year 2000 compliant; economic and aviation/aerospace market stability and Company profitability. Should one or more of these risks or uncertainties materialize adversely, or should underlying assumptions or estimates prove incorrect, actual results may vary materially from those described.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's exposure to market risk is limited to fluctuating interest rates under its unsecured bank credit agreements, and foreign exchange rates. During fiscal 1999 and 1998, the Company did not utilize derivative financial instruments to offset these risks.
At May 31, 1999, $65,300 was available under credit lines with domestic banks, $110,000 was available under revolving credit and term loan agreements with domestic banks, and $3,500 was available under credit agreements with foreign banks (credit facilities). Interest on amounts borrowed under the credit facilities is based on an overnight bid rate. While the Company utilized these credit facilities during fiscal 1999, as of May 31, 1999, there was no outstanding balance. A hypothetical 10 percent increase to the average interest rate under the credit facilities would not have had a material impact on the results of operations for the Company during fiscal 1999.
Revenues and expenses of the Company's foreign operations in The Netherlands are translated at average exchange rates during the year and balance sheet accounts are translated at year-end exchange rates. Balance sheet translation adjustments are excluded from the results of operations and are recorded in stockholders' equity as a component of accumulated other comprehensive income (loss). A hypothetical 10 percent devaluation of foreign currencies against the U.S. dollar would not have a material impact on the financial position or results of operations of the Company.
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* See "Forward Looking Statements" section of this item.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF AAR CORP.:
We have audited the accompanying consolidated balance sheets of AAR CORP. and subsidiaries as of May 31, 1999 and 1998, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended May 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AAR CORP. and subsidiaries as of May 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended May 31, 1999 in conformity with generally accepted accounting principles.
KPMG LLP
Chicago, Illinois June 23, 1999
AAR CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes to consolidated financial statements are an integral part of these statements.
AAR CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
ASSETS
The accompanying notes to consolidated financial statements are an integral part of these statements.
AAR CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
The accompanying notes to consolidated financial statements are an integral part of these statements.
AAR CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE THREE YEARS ENDED MAY 31, 1999
The accompanying notes to consolidated financial statements are an integral part of these statements.
AAR CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes to consolidated financial statements are an integral part of these statements.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
AAR CORP. (the Company) supplies a variety of products and services to the worldwide aviation/aerospace industry. Products and services are sold primarily to commercial, domestic and foreign airlines; business aircraft operators; aviation original equipment manufacturers; aircraft leasing companies; domestic and foreign military agencies and independent aviation support companies.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries after elimination of intercompany accounts and transactions.
The Company conducts portions of its business through joint venture investments accounted for under the equity method. These equity affiliates are primarily engaged in the distribution of certain engine parts and aircraft rotable spares to worldwide aviation customers. The financial position and results of operations for the joint ventures during fiscal 1999 and 1998 are not material.
REVENUE RECOGNITION
Sales and related cost of sales are recognized primarily upon shipment of products and performance of services. Lease revenue is recognized as earned.
NEW ACCOUNTING STANDARDS
FASB Statement of Financial Accounting Standards (SFAS) No. 130 "Reporting Comprehensive Income" is effective for fiscal years beginning after December 15, 1997. SFAS No. 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. The Company adopted the provisions of SFAS No. 130 in fiscal 1999.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
NEW ACCOUNTING STANDARDS (CONTINUED)
SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" is effective for fiscal years beginning after December 15, 1997. SFAS No. 131 establishes standards for public companies to report financial and descriptive information about reportable operating segments in annual financial statements and interim financial reports issued to stockholders. The Company operates in one segment: Aviation Services. The Company's determination of its reportable segment is based on the commonalities among the products and services within its Aviation Services segment, and is consistent with the manner in which the Company's management reviews and evaluates operating performance.
SFAS No. 132 "Employers' Disclosures about Pensions and Other Postretirement Benefits" is effective for fiscal years beginning after December 15, 1997. SFAS No. 132 revises disclosures for pension and other postretirement plans, but does not change the measurement or recognition of liabilities or expense related to pension or other postretirement plans. The Company adopted the provisions of SFAS No. 132 in fiscal 1999.
In March 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accounts (ACSEC) issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." In April 1998, the ACSEC issued SOP 98-5, "Reporting on the Costs of Start-Up Activities." The adoption of SOP 98-1 and SOP 98-5 did not have a material effect on the Company's financial position or results of operations during fiscal 1999.
SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" is effective for fiscal years beginning after June 15, 2000. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for certain hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The Company is evaluating the new Statement's provisions to determine the impact, if any, and will adopt SFAS No. 133 in its first quarter of fiscal 2002.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of three months or less to be cash equivalents. At May 31, 1999 and 1998, cash equivalents of approximately $116 and $177, respectively, represent investments in funds holding high-quality commercial paper, Eurodollars and U.S. Government agency-issued securities. The carrying amount of cash equivalents approximates fair value at May 31, 1999 and 1998, respectively.
TRANSFER OF FINANCIAL ASSETS
During fiscal 1998, the Company adopted SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", which requires the Company to recognize the financial and servicing assets it controls and the liabilities it has incurred, and to derecognize financial assets when control has been surrendered.
During fiscal 1999, the Company amended its agreement to sell, on a revolving basis, an interest in a defined pool of trade accounts receivable. Among the terms amended, the amount of accounts receivable which could be sold under the program was reduced from $50 million to $35 million. The Company, as agent for the purchaser of the accounts receivable, retains collection and administrative responsibilities for the participating interests of accounts receivable. Accounts receivable sold under this arrangement were $25,300 and $0 at May 31, 1999 and 1998, respectively.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
FOREIGN CURRENCY
Gains and losses on foreign currency translation and foreign exchange contracts are determined in accordance with the method of accounting prescribed by SFAS No. 52. All balance sheet accounts of foreign and certain domestic subsidiaries transacting business in currencies other than the Company's functional currency are translated at year-end or historical exchange rates. Revenues and expenses are translated at average exchange rates during the year. Translation adjustments are excluded from the results of operations and are recorded in Stockholders' equity as a component of accumulated other comprehensive income (loss).
FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF MARKET OR CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of market or credit risk consist principally of trade receivables. While the Company's trade receivables are diverse based on the number of entities and geographic regions, the majority are in the aviation/aerospace industry. The Company performs evaluations of customers' financial condition prior to extending credit privileges and performs ongoing credit evaluations of payment experience, current financial condition and risk analysis. The Company typically requires collateral in the form of security interest in assets, letters of credit, and/or obligation guarantees from financial institutions, or sells its receivables, usually on a nonrecourse basis, for transactions other than normal trade terms.
SFAS No. 107 "Disclosures about Fair Value of Financial Instruments" requires disclosure of the fair value of certain financial instruments. Cash and cash equivalents, accounts receivable, short-term borrowings, accounts payable and accrued liabilities are reflected in the consolidated financial statements at fair value because of the short-term maturity of these instruments. The carrying value of noncurrent notes receivable and long-term debt bearing a variable interest rate approximates fair market value.
Fair value estimates are made at a specific point in time based on relevant market information about the financial instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
INVENTORIES
Inventories are priced at the lower of cost or market. Cost is determined by either the specific identification, average cost or first-in, first-out method.
The following is a summary of inventories:
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
EQUIPMENT UNDER OPERATING LEASES
Lease revenue is recognized as earned. The cost of the asset under lease is original purchase price plus overhaul costs. Depreciation is computed on a straight-line method over the estimated service life of the equipment and maintenance costs are expensed as incurred. The balance sheet classification is based on the lease term with fixed-term leases less than twelve months classified as short term and all others classified as long term.
Equipment on short-term lease consists of aircraft engines and parts on or available for lease to satisfy customers' immediate short-term requirements. The leases are renewable with fixed terms, which generally vary from one to twelve months. Equipment on long-term lease consists of aircraft and engines on lease to customers with a lease term greater than twelve months.
PROPERTY, PLANT AND EQUIPMENT
Depreciation is computed on the straight-line method over useful lives of 10-40 years for buildings and improvements and 3-10 years for equipment, furniture and fixtures and capitalized software. Leasehold improvements are amortized over the shorter of the estimated useful life or the term of the applicable lease.
Repairs and maintenance expenditures are expensed as incurred. Upon sale or disposal, cost and accumulated depreciation are removed from the accounts and related gains and losses are included in results of operations.
LEVERAGED LEASES
The Company acts as an equity participant in leveraged lease transactions. The equipment cost in excess of equity contribution is financed by third parties in the form of secured debt. Under the lease agreements, the third parties have no recourse against the Company for nonpayment of the obligations. The third-party debt is collateralized by the lessees' rental obligations and the leased equipment.
The Company has ownership rights to the leased assets and is entitled to the investment tax credits and benefits of tax deductions for depreciation on the leased assets and for interest on the secured debt financing.
COST IN EXCESS OF UNDERLYING NET ASSETS OF ACQUIRED COMPANIES
The cost in excess of underlying net assets of acquired companies is being amortized over a period of forty years. The increase in cost in excess of underlying net assets of acquired companies at May 31, 1999 is attributable to the Company's acquisition of Tempco during fiscal 1999, as well as final purchase price adjustments related to acquisitions made during fiscal 1998. Amortization expense was $802, $565 and $223 in fiscal 1999, 1998 and 1997, respectively. Accumulated amortization is $4,975 and $4,173 at May 31, 1999 and 1998, respectively. The Company evaluates the existence of impairment on the basis of whether the cost in excess of underlying net assets of acquired companies is fully recoverable from projected, undiscounted net cash flows.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)
INCOME TAXES
Income taxes are determined in accordance with SFAS No. 109.
The benefits of investment tax credits are recognized for financial reporting purposes under the deferral method of accounting for leveraged leases. The investment tax credits are recognized in the year earned for income tax purposes.
STATEMENTS OF CASH FLOWS
Supplemental information on cash flows follows:
USE OF ESTIMATES
Management of the Company has made estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities to prepare these consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.
RECLASSIFICATION
Certain amounts in the prior years' consolidated financial statements have been reclassified to conform to the current year's presentation.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
2. FINANCING ARRANGEMENTS
Term loans consisted of:
Short-term borrowing activity was as follows:
At May 31, 1999, aggregate unsecured bank credit arrangements were $178,800. Of this amount, $65,300 was available under credit lines with domestic banks, $110,000 was available under revolving credit and term loan agreements with domestic banks and $3,500 was available under credit agreements with foreign banks. All domestic and foreign credit lines were unused at May 31, 1999. There are no compensating balance requirements in connection with domestic or foreign lines of credit. Borrowings under domestic bank lines bear interest at or below the corporate base rate.
The Company may borrow a maximum of $110,000 (available through February 9, 2002) under revolving credit and term loan agreements with domestic banks. Revolving credit borrowings may, at the Company's option, be converted to term loans payable in equal quarterly installments over five years. Interest is based on corporate base rate or quoted Eurodollar or multicurrency rates during the revolving credit period and 1/2% over corporate base rate or quoted Eurodollar rate thereafter. There were no borrowings under these agreements outstanding at May 31, 1999. There are no compensating balance requirements on any of the committed lines, but the Company is required to pay a commitment fee. There are no restrictions on the withdrawal or use of these funds.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
2. FINANCING ARRANGEMENTS -- (CONTINUED)
Long-term debt was as follows:
The Company is subject to a number of covenants under the revolving credit and term loan agreements, including restrictions which relate to the payment of cash dividends, maintenance of minimum net working capital and tangible net worth levels, sales of assets, additional financing, purchase of the Company's shares and other matters. The Company is in compliance with all restrictive financial provisions of the agreements. At May 31, 1999, unrestricted consolidated retained earnings available for payment of dividends and purchase of the Company's shares was approximately $18,482. Effective June 1, 1999, unrestricted consolidated retained earnings increased to $39,318 due to inclusion of 50% of the consolidated net income of the Company for fiscal 1999. The aggregate amount of long-term debt maturing during each of the next five fiscal years is $521 in 2000, $524 in 2001, $65,499 in 2002, $475 in 2003 and $51,479 in 2004. The Company's long-term debt was estimated to have a fair value of approximately $185,639 at May 31, 1999 and was based on estimates using discounted future cash flows at an assumed rate for borrowings currently prevailing in the marketplace for similar instruments.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
3. INCOME TAXES
The provision for income taxes included the following components:
The deferred tax provisions result primarily from differences between financial reporting and tax income arising from depreciation and leveraged leases.
Deferred tax liabilities and assets result primarily from the differences in the timing of the recognition for transactions between financial reporting and income tax purposes and consist of the following components:
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
3. INCOME TAXES -- (CONTINUED)
The Company has determined that the realization of deferred tax assets is more likely than not, and that a valuation allowance is not required based upon the Company's history of prior operating earnings, its expectations for continued future earnings and the scheduled reversal of deferred tax liabilities, primarily related to leveraged leases, which exceed the amount of the deferred tax assets.
The provision for income taxes differs from the amount computed by applying the U.S. Federal statutory income tax rate of 35% for fiscal 1999, 1998 and 1997, for the following reasons:
4. COMMON STOCK AND STOCK OPTION PLANS
The Company has established stock option plans for officers and key employees of the Company. Stock option awards typically expire ten years from the date of grant or earlier upon termination of employment, become excercisable in five equal increments on successive grant anniversary dates at the New York Stock Exchange closing stock price on the date of grant and are accompanied by reload features and, for certain individuals, stock rights exercisable in the event of a change in control of the Company.
The Company accounts for these plans under APB No. 25, under which no compensation cost has been recognized. Proforma information regarding net income and earnings per share is required by SFAS No. 123 and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123. The fair value of each option grant, including reloads, is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
The fair value weighted average per share of stock options granted during fiscal years 1999, 1998 and 1997 was $5.20, $5.04 and $4.57, respectively. Had compensation cost for stock options awarded under the plans been determined in accordance with SFAS No. 123, the Company's net income and earnings per share would have been changed to the following proforma amounts:
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
4. COMMON STOCK AND STOCK OPTION PLANS -- (CONTINUED)
A summary of changes in stock options granted to officers, key employees and non-employee directors under stock option plans for the three years ended May 31, 1999 follows:
The following table provides additional information regarding options outstanding as of May 31,1999:
The AAR CORP. Stock Benefit Plan also provides for the grant of restricted stock awards. Restrictions are released at the end of applicable restricted periods. The number of shares and the restricted period, which varies from two to ten years, are determined by the Compensation Committee of the Board of Directors. The market value of the award on the date of grant is recorded as a deferred expense, Common stock and Capital surplus. The deferred expense is included in results of operations over the vesting period. The expense relating to outstanding restricted stock awards was $1,667, $1,400 and $1,054 in fiscal 1999, 1998 and 1997, respectively.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
4. COMMON STOCK AND STOCK OPTION PLANS -- (CONTINUED)
The AAR CORP. Employee Stock Purchase Plan is open to employees of the Company (other than officers, directors or participants in other stock option plans of the Company) and permits employees to purchase common stock in periodic offerings by payroll deductions.
The numbers of options and awards outstanding and available for grant or issuance for each of the Company's stock plans are as follows:
Pursuant to a shareholder rights plan adopted in 1997, each outstanding share of the Company's common stock carries with it a Right to purchase one and one half additional shares at a price of $83.33 per share (adjusted to reflect the February 23, 1998 stock split and subject to further antidilution adjustments). The Rights become exercisable (and separate from the shares) when certain specified events occur, including the acquisition of 15% or more of the common stock by a person or group (an "Acquiring Person") or the commencement of a tender or exchange offer for 15% or more of the common stock.
In the event that an Acquiring Person acquires 15% or more of the common stock, or if the Company is the surviving corporation in a merger involving an Acquiring Person or if the Acquiring Person engages in certain types of self-dealing transactions, each Right entitles the holder to purchase for $83.33 per share, (or the then-current exercise price) shares of the Company's common stock having a market value of $166.66 (or two times the exercise price), subject to certain exceptions. Similarly, if the Company is acquired in a merger or other business combination or 50% or more of its assets or earning power is sold, each Right entitles the holder to purchase at the then-current exercise price that number of shares of common stock of the surviving corporation having a market value of two times the exercise price. The Rights, which do not entitle the holder thereof to vote or to receive dividends, replace the common stock purchase rights which were initially distributed to the Company's shareholders in 1987 and which expired by their own terms on August 6, 1997. The Rights will expire on August 6, 2007, and may be redeemed by the Company for $.01 per Right under certain circumstances.
On September 21, 1990, the Board of Directors authorized the Company to purchase up to 1,500 shares (adjusted for the three-for-two stock split) of the Company's common stock on the open market or through privately negotiated transactions. As of May 31, 1999, the Company had purchased 1,083 shares of its common stock on the open market under this program at an average price of $12.46 per share.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
5. EARNINGS PER SHARE
The computation of basic earnings per share is based on the weighted average number of common shares outstanding during the year. Diluted earnings per share is based on the weighted average number of common shares outstanding during the year plus, when their effect is dilutive, common stock equivalents consisting of shares subject to stock options. The following table provides a reconciliation of the computations of basic and diluted earnings per share information for each of the years in the three-year period ended May 31, 1999.
In January 1998, the Board of Directors declared a three-for-two stock split which was effected in the form of a stock dividend on February 23, 1998 to shareholders of record February 2, 1998, and a quarterly cash dividend of 8.5 cents per share on the increased shares, which effectively increased the cash dividend payment by 6.25%. Prior year earnings per share amounts have been restated to reflect the three-for-two stock split.
6. EMPLOYEE BENEFIT PLANS
The Company has defined contribution or defined benefit plans covering substantially all full-time domestic employees and certain employees in The Netherlands.
DEFINED BENEFIT PLANS
The pension plans for domestic, salaried employees have benefit formulas primarily based on years of service and compensation. The pension benefit for hourly employees is generally based on a fixed amount per year of service. The Company follows the provisions of SFAS No. 87 "Employers' Accounting for Pensions" and SFAS No. 132 "Employer's Disclosures about Pension and Other Postretirement Benefits" for all pension and postretirement plans.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
6. EMPLOYEE BENEFIT PLANS -- (CONTINUED)
The Company's funding policy for domestic plans is to contribute annually, at a minimum, an amount which is deductible for Federal income tax purposes and that is sufficient to meet actuarially computed pension benefits. Contributions are intended to provide for benefits attributed to service to date and for benefits expected to be earned in the future. The assets of the pension plans are invested primarily in mutual funds, common stocks, investment grade bonds and U.S. Government obligations.
Certain foreign operations of domestic subsidiaries also have pension plans. In most cases, the plans are defined benefit in nature. Assets of the plans are comprised of insurance contracts. Benefit formulas are similar to those used by domestic plans. It is the policy of these subsidiaries to fund at least the minimum amounts required by local law and regulation.
The following table sets forth the plans' funded status, including the change in plan assets, and the amount recognized in the Company's Consolidated Balance Sheets.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
6. EMPLOYEE BENEFIT PLANS -- (CONTINUED)
The projected benefit obligation for domestic plans is determined using an assumed weighted average discount rate of 7.5% for fiscal 1999 and 1998, and an assumed average compensation increase of 5.0%. The expected long-term rate of return on assets is 10.0% for fiscal 1999 and 1998. The unrecognized actuarial losses, prior service cost and transition obligation are amortized on a straight-line basis over the estimated average future service period.
The projected benefit obligation for nondomestic plans is determined using an assumed weighted average discount rate of 5.5% for fiscal 1999 and 1998, and an assumed average compensation increase of 2.0% for the first two years and 4.0% thereafter. The expected long-term rate of return on assets is 6.5% for fiscal 1999 and 1998.
Pension expense charged to results of operations includes the following components:
DEFINED CONTRIBUTION PLAN
The defined contribution plan is a profit sharing plan which is intended to qualify as a 401(k) plan under the Internal Revenue Code. Under the plan, employees may contribute up to 15.0% of their pretax compensation, subject to applicable regulatory limits. The Company may make matching contributions up to 6.0% of compensation. Participants vest on a pro-rata basis in Company contributions during the first three years of employment. Expense charged to results of operations was $1,491, $1,174 and $930 in fiscal 1999, 1998 and 1997, respectively.
DIRECTOR, EXECUTIVE AND KEY EMPLOYEE RETIREMENT BENEFIT AND PROFIT SHARING PLANS
The Company provides its outside directors with benefits upon retirement on or after age 65 provided they have completed at least five years of service as a director. Benefits are paid quarterly in cash in an amount equal to 25.0% of the annual retainer fee payable by the Company to active outside directors. Payment of benefits commences upon retirement and continues for a period equal to the total number of years of the retired director's service as a director to a maximum of ten years, or death, whichever occurs first.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
6. EMPLOYEE BENEFIT PLANS -- (CONTINUED)
The Company also provides supplemental retirement and profit sharing benefits for current and former executives and key employees to supplement benefits provided by the Company's other benefit plans. The plans are not fully funded and may require funding in the event of a change in control of the Company as determined by the Company's Board of Directors. Expense charged to results of operations for these plans was $1,162, $1,231 and $970 in fiscal 1999, 1998 and 1997, respectively.
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company provides health and life insurance benefits for certain eligible employees and retirees under a variety of plans. Generally these benefits are contributory with retiree contributions adjusted annually. The postretirement plans are unfunded and the Company has the right to modify or terminate any of these plans in the future, in certain cases, subject to union bargaining agreements. In fiscal 1995, the Company completed termination of postretirement healthcare and life insurance benefits attributable to future services of collective bargaining and other domestic employees.
Postretirement benefit cost for the years ended May 31, 1999, 1998 and 1997 included the following components:
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
6. EMPLOYEE BENEFIT PLANS -- (CONTINUED)
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (CONTINUED)
The assumed discount rate used to measure the accumulated postretirement benefit obligation was 7.5% at May 31, 1999 and 1998. The assumed rate of future increases in healthcare costs was 7.5% and 8.1% in fiscal 1999 and 1998, respectively, declining to 5.25% by the year 2004 and remaining at that rate thereafter. A one percent increase in the assumed healthcare cost trend rate would increase the accumulated postretirement benefit obligation by approximately $43 as of May 31, 1999 and would not result in a significant change to the annual postretirement benefit expense.
7. COMMITMENTS AND CONTINGENCIES
The Company leases certain facilities and equipment under agreements that expire at various dates through 2011. Rental expense under these leases was $9,843, $6,991 and $6,660 in fiscal 1999, 1998 and 1997, respectively.
Future minimum payments under leases with initial or remaining terms of one year or more at May 31, 1999 were $11,222 for fiscal 2000, $3,526 for fiscal 2001, $2,836 for fiscal 2002, $1,925 for fiscal 2003 and $2,298 for fiscal 2004 and thereafter.
The Company routinely issues letters of credit, performance bonds or credit guarantees in the ordinary course of its business. These instruments are typically issued in conjunction with insurance contracts or other business requirements. The total of these instruments outstanding at May 31, 1999 was approximately $22,700.
The Company is involved in various claims and legal actions, including environmental matters, arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial condition or results of operations.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
8. INVESTMENT IN LEVERAGED LEASES
From time to time, the Company acquires aircraft under lease that qualify for leveraged lease accounting treatment. Typically, these are long-term leases of late-model aircraft operated by major carriers where the Company is an equity participant of at least twenty percent and there is a third-party provider of nonrecourse debt of the remaining equipment cost.
During the lease term the Company is required, in accordance with SFAS No. 13, to adjust the elements of the investment in leveraged leases to reflect changes in important economic assumptions, such as the renegotiating of the interest rate on the nonrecourse debt or changes in income tax rates. In addition, the Company may sell options or other rights to the residual proceeds over the book value at the end of the lease term.
The Company's net investment in leveraged leases is comprised of the following elements:
Pretax income from leveraged leases was $702, $1,329 and $0 in fiscal 1999, 1998 and1997, respectively.
9. OTHER NONCURRENT ASSETS
At May 31, 1999 and 1998, other noncurrent assets consisted of the following:
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
10. ACQUISITIONS
On October 19, 1998, the Company acquired substantially all of the assets and assumed certain liabilities of Tempco Hydraulics Inc. (Tempco), a regional aircraft landing gear repair and overhaul business. The purchase price of approximately $7.5 million was paid with a combination of cash and a note. The transaction was recorded under the purchase method of accounting. The Company has included in its consolidated financial statements the results of operations of Tempco since the date of acquisition.
On December 31, 1997, the Company acquired substantially all of the assets and assumed certain liabilities of AVSCO Aviation Service Corporation (AVSCO), a distributor of factory-new parts and accessories to the commercial, regional/commuter and general aviation markets. The purchase price of approximately $18.4 million was paid with a combination of cash and a note and the transaction was recorded under the purchase method of accounting. The Company has included in its consolidated financial statements the results of operations of AVSCO since the date of acquisition.
On October 24, 1997, the Company purchased the stock of ATR International, Inc. (ATR), a company which engineers and manufactures composite parts and structures for the aviation/aerospace industry. The Company acquired ATR for approximately $19 million cash and the transaction was recorded under the purchase method of accounting. The Company has included in its consolidated financial statements the results of operations of ATR since the date of acquisition.
On June 2, 1997, the Company acquired substantially all of the assets and assumed certain liabilities of Cooper Aviation Industries, Inc. (Cooper), a distributor of factory-new aviation parts and accessories to the commercial, regional/commuter and general aviation markets. The purchase price was paid by issuing 140 thousand common shares (adjusted for the three-for-two stock split) and was recorded under the purchase method of accounting. In addition, the Company assumed short-term debt which was paid off by the Company during the first quarter of fiscal 1998. The Company has included in its consolidated financial statements the results of operations of Cooper since the date of acquisition.
The historical operating results of the acquisitions for the periods preceding the acquisitions are not material when compared to the operating results of the Company.
11. BUSINESS SEGMENT INFORMATION
The carrying value of long-lived assets in Company facilities located in foreign countries, and sales from these facilities in total, are not material to the consolidated financial statements.
Export sales from the Company's U.S. operations to unaffiliated customers, the majority of which are located in Europe, the Middle East, Canada, Mexico, South America and Asia (including sales through foreign sales offices of domestic subsidiaries), were approximately $209,712 (22.8% of total net sales), $202,481 (25.9% of total net sales) and $204,808 (34.8% of total net sales) in fiscal 1999, 1998 and 1997, respectively.
Sales to the U.S. Government, its agencies and its contractors were approximately $98,954 (10.8% of total net sales), $83,114 (10.6% of total net sales) and $82,125 (13.9% of total net sales) in fiscal 1999, 1998 and 1997, respectively. Sales to the Company's largest customer were approximately $135,100 (14.7% of total net sales) during fiscal 1999.
AAR CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) (IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
12. SELECTED QUARTERLY DATA (UNAUDITED)
The unaudited selected quarterly data for fiscal years ended May 31, 1999 and 1998 are as follows.
13. ALLOWANCES FOR DOUBTFUL ACCOUNTS
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item regarding the Directors of the Company is incorporated by reference to the information contained under the caption "Board of Directors" in the Company's definitive proxy statement for the 1999 Annual Meeting of Stockholders.
The information required by this item regarding the Executive Officers of the Company appears under the caption "Executive Officers of the Registrant" in Part I above.
The information required by this item regarding the compliance with Section 16(a) of the Securities Exchange Act of 1934 ("Exchange Act") is incorporated by reference to the information contained under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive proxy statement for the 1999 Annual Meeting of Stockholders.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the information contained under the captions "Executive Compensation and Other Information" (but excluding the following sections thereof, "Compensation Committee's Report on Executive Compensation" and "Stockholder Return Performance Graphs"); "Employment and Other Agreements" and "Directors' Compensation" in the Company's definitive proxy statement for the 1999 Annual Meeting of Stockholders.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference to the information contained under the caption "Security Ownership of Management and Others" in the Company's definitive proxy statement for the 1999 Annual Meeting of Stockholders.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the information contained under the caption "Certain Relationships and Related Transactions" in the Company's definitive proxy statement for the 1999 Annual Meeting of Stockholders.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
FINANCIAL STATEMENTS
EXHIBITS
The Exhibits filed as a part of this report are set forth in the Exhibit Index contained elsewhere herein. Each of the material contracts identified as Exhibits 10.1 through 10.10 is a management contract or compensatory plan or arrangement.
REPORTS ON FORM 8-K
The Company filed no reports on Form 8-K during the three-month period ended May 31, 1999.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: August 18, 1999 BY: /s/ DAVID P. STORCH -------------------------------- David P. Storch PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
- ----------------- Notes:
1 Incorporated by reference to Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1987.
2 Incorporated by reference to Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1989.
3 Incorporated by reference to Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1986.
4 Incorporated by reference to Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1988.
5 Incorporated by reference to Exhibits to the Registrant's Quarterly Report on Form 10-Q for the Quarter ended November 30, 1989.
6 Incorporated by reference to Exhibits to Registrant's Registration Statement on Form S-3 filed August 27, 1991.
7 Incorporated by reference to Exhibits to the Registrant's Quarterly Report on Form 10-Q for the quarter ended November 30, 1991
8 Incorporated by reference to Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1985.
9 Incorporated by reference to Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1992.
10 Incorporated by reference to Exhibits to the Registrant's Current Reports on Form 8-K dated October 24, 1989 and October 12, 1993, respectively.
11 Incorporated by reference to Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1993.
12 Incorporated by reference to Exhibits to Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1994.
13 Incorporated by reference to Exhibits to the Registrant's Quarterly Report on Form 10-Q for the quarter ended November 30, 1994.
14 Incorporated by reference to Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1995.
15 Incorporated by reference to Exhibits to the Registrant's Quarterly Report on Form 10-Q for the quarter ended November 30, 1996.
16 Incorporated by reference to Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1996.
17 Incorporated by reference to Exhibits to the Registrant's Current Report on Form 8-K dated August 4, 1997.
18 Incorporated by reference to Exhibits to the Registrant's Registration Statement on Form S-3 filed December 10, 1997.
19 Incorporated by reference to Exhibits to the Registrant's Quarterly Report on Form 10-Q for the quarter ended February 28, 1998.
20 Incorporated by reference to Exhibits to the Registrant's Registration Statement on Form S-3 filed May 15, 1998.
21 Incorporated by reference to Exhibits to the Registrant's Quarterly Report on Form 10-Q for the quarter ended November 30, 1997.
22 Incorporated by reference to Exhibits to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1998.