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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended February 29, 2016

or

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

For the transition period from                     to                     

Commission File No. 1-6263

AAR CORP.

(Exact name of registrant as specified in its charter)

(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, 2016, there were 34,748,311 shares of the registrant’s Common Stock, $1.00 par value per share, outstanding.

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AAR CORP. and Subsidiaries

Quarterly Report on Form 10-Q

For the Quarter Ended February 29, 2016

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PART I — FINANCIAL INFORMATION

Item 1 — Financial Statements

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of February 29, 2016 and May 31, 2015

(In millions, except share data)

ASSETS

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

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AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of February 29, 2016 and May 31, 2015

(In millions, except share data)

LIABILITIES AND EQUITY

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

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AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Operations

For the Three and Nine Months Ended February 29, 2016 and February 28, 2015

(Unaudited)

(In millions)

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

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AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

For the Nine Months Ended February 29, 2016 and February 28, 2015

(Unaudited)

(In millions)

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

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AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

For the Nine Months Ended February 29, 2016 and February 28, 2015

(Unaudited)

(In millions)

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

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AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Changes in Equity

For the Nine Months Ended February 29, 2016

(Unaudited)

(In millions)

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 29, 2016

(Unaudited)

(Dollars in millions, 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, 2015 has been derived from audited financial statements.  To prepare the financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”), 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 GAAP, 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, 2016, the Condensed Consolidated Statements of Operations and the Condensed Consolidated Statements of Comprehensive Income for the three- and nine-month periods ended February 29, 2016 and February 28, 2015, the Condensed Consolidated Statements of Cash Flows for the nine-month periods ended February 29, 2016 and February 28, 2015, and the Condensed Consolidated Statement of Changes in Equity for the nine-month period ended February 29, 2016.  The results of operations for such interim periods are not necessarily indicative of the results for the full year.

New Accounting Pronouncements

In April 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity which requires that a disposal representing a strategic shift that has or will have a major effect on an entity’s financial results or a business activity classified as held for sale should be reported as discontinued operations. This ASU also expands the disclosure requirements for discontinued operations and adds new disclosures for individually significant dispositions that do not qualify as discontinued operations. The Company adopted this guidance on June 1, 2015 which resulted in expanded disclosures related to the income statement and cash flow activities of our discontinued operations.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which provides guidance for revenue recognition.  This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets.  This ASU will supersede the revenue recognition requirements in ASC 605, Revenue Recognition, and most industry-specific guidance.  This ASU also supersedes certain cost guidance included in Subtopic 605-35, Revenue Recognition-Construction-Type and Production-Type Contracts.  In August 2015, the FASB issued ASU No. 2015-14 which deferred the effective date of the new standard by one year which will make the new standard effective for us beginning June 1, 2018.  We are currently evaluating the impact of the adoption of this new standard on our consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs.  This ASU amends existing guidance to require the presentation of debt issuance costs in the balance sheet as a deduction from the carrying amount of the related debt liability instead of a deferred charge.  This new standard will be effective for us beginning June 1, 2016.  We are currently evaluating the impact of the adoption of this new standard on our consolidated financial statements.

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 29, 2016

(Unaudited)

(Dollars in millions, except per share amounts)

In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes.  This ASU amends existing guidance to require the presentation of deferred tax liabilities and assets as noncurrent within a classified statement of financial position.  Adoption of this new standard may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented.  This new standard will be effective for us beginning June 1, 2017 with early adoption permitted.  We are currently evaluating the impact of the adoption of this new standard on our consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases.  This ASU amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets, including those classified as operating leases under the current accounting guidance.  In addition, this ASU will require new qualitative and quantitative disclosures about the Company’s leasing activities.  This new standard will be effective for us beginning June 1, 2019 with early adoption permitted.  This ASU requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief.  We are currently evaluating the impact of the adoption of this new standard on our consolidated financial statements.

Note 2 — Discontinued Operations

On March 26, 2015, we completed the sale of our Telair Cargo Group to TransDigm, Inc.  The Telair Cargo Group was comprised of Telair International, Telair US, and Nordisk Aviation Products.  Cash received at closing in the fourth quarter of fiscal 2015 before fees and expenses was $705 million.  The sale also allowed for contingent consideration of up to $35 million based on the occurrence of certain post-closing events related to the A400M cargo system.  We recognized a pre-tax gain on the sale (net of transaction expenses and fees) of $198.6 million in the fourth quarter of fiscal 2015.

In the first quarter of fiscal 2016, we recognized a gain of $27.7 million net of expenses representing the resolution of the contingent consideration related to the A400M cargo system.

During fiscal 2015, we also announced our intention to sell our Precision Systems Manufacturing (“PSM”) business comprised of our metal and composite machined and fabricated parts manufacturing operations.  We recognized impairment charges of $57.5 million during fiscal 2015 to reduce the carrying value of the PSM business’s net assets to their expected value at the time of sale.

Telair Cargo Group and PSM are reported as discontinued operations in the Condensed Consolidated Statements of Operations for all periods presented.  Interest expense allocated to discontinued operations was $0 million and $2.8 million during the three months ended February 29, 2016 and February 28, 2015, respectively, and $0 million and $8.4 million during the nine months ended February 29, 2016 and February 28, 2015, respectively.  No amounts for general corporate overhead were allocated to discontinued operations.

Liabilities of discontinued operations of $5.8 million and $5.4 million at February 29, 2016 and May 31, 2015, respectively, were classified as Accrued Liabilities on the Condensed Consolidated Balance Sheet.  Operating income (loss) from discontinued operations was comprised of the following:

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 29, 2016

(Unaudited)

(Dollars in millions, except per share amounts)

Note 3 — 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 large airframe maintenance contracts and performance-based logistics programs are recognized by the percentage of completion method, based on the relationship of costs incurred to date to the estimated total costs.  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 to our customers contain multiple elements or deliverables, such as program and warehouse management, parts distribution, and maintenance and repair services.  We recognize revenue for each element or deliverable that can be identified as a separate unit of accounting at the time of delivery based upon the relative fair value of the products and services.

Included in accounts receivable as of February 29, 2016 and May 31, 2015, are $24.6 million and $21.1 million, respectively, of unbilled accounts receivable related to a defense-related supply program.  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.

Note 4 — Accounting for Stock-Based Compensation

Restricted Stock

In August 2015, as part of our annual long-term stock incentive compensation, we granted 109,269 shares of performance-based restricted stock and 28,069 shares of time-based restricted stock to eligible employees.  The grant date fair value per share for both grants was $26.62.  In June 2015, we also granted 45,000 shares of time-based restricted stock to members of the Board of Directors with a grant date fair value per share of $29.54.

Expense charged to operations for restricted stock was $1.4 million and $1.6 million during the three months ended February 29, 2016 and February 28, 2015, respectively, and $3.6 million and $4.3 million during the nine months ended February 29, 2016 and February 28, 2015, respectively.

Stock Options

The total intrinsic value of stock options exercised during the nine months ended February 29, 2016 and February 28, 2015 was $0.9 million and $1.5 million, respectively.   Expense charged to operations for stock options was $0.9 million and $0.8 million during the three months ended February 29, 2016 and February 28, 2015, respectively, and $2.6 million and $2.2 million during the nine months ended February 29, 2016 and February 28, 2015, respectively.

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 29, 2016

(Unaudited)

(Dollars in millions, except per share amounts)

Note 5 — Inventory

The summary of inventories is as follows:

We had eight aircraft held for sale comprised of five fixed-wing and three rotary-wing aircraft at February 29, 2016 and eleven aircraft held for sale comprised of five fixed-wing and six rotary-wing aircraft at May 31, 2015.

Note 6 — Aircraft Sale-Leaseback Transactions

During the fourth quarter of fiscal 2015, we entered into a sale-leaseback transaction for our two S-92 rotary-wing aircraft resulting in the recognition of a loss of $1.1 million.  We received proceeds of $40.3 million in fiscal 2015 which were deferred as a sale-leaseback advance pending completion of the sale transactions.  Both of the S-92 aircraft sales were completed in fiscal 2016.

During the nine-month period ended February 29, 2016, we received proceeds of $38.5 million from sale-leaseback transactions for two AW-189 rotary-wing aircraft.  The $1.7 million gain realized on the sale has been deferred and is being amortized over the lease term of ten years.

Note 7 — Income Taxes

During the third quarter of fiscal 2016, we completed a reconciliation of our tax basis assets and liabilities and an analysis of our income tax payable which identified prior year immaterial errors netting to $0.2 million.  The correction of these errors was recognized in the three months ended February 29, 2016 with $2.7 million recognized as income tax expense in discontinued operations and $2.5 million recognized as income tax benefit within income from continuing operations.  Further, in connection with the reconciliation of our tax basis assets and liabilities, we corrected certain amounts within deferred tax assets and liabilities, accrued liabilities, and goodwill on our condensed consolidated balance sheet as of February 29, 2016.  We have concluded these errors were not material to any prior reporting periods.

During the third quarter of fiscal 2016, we recognized $2.8 million of income tax expense in discontinued operations related to changes in estimates associated with tax provision to federal income tax return filing differences.

Note 8 — Supplemental Cash Flow Information

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 29, 2016

(Unaudited)

(Dollars in millions, except per share amounts)

Note 9 — Financing Arrangements

A summary of the carrying amount of our debt is as follows:

At February 29, 2016, the carrying value of our variable rate and fixed rate debt had a fair value that approximates the carrying value of $195.7 million.  These debt instruments are classified as Level 3 in the fair value hierarchy which is defined as a fair value determined based upon one or more significant unobservable inputs.

We are subject to a number of covenants under our financing arrangements, including restrictions that relate to the payment of cash dividends, maintenance of debt-to-EBITDA and interest coverage ratios, sales of assets, additional financing, purchase of our shares and other matters.  We are in compliance with all financial and other covenants under our financing arrangements.

Convertible Notes

During the three-month period ended August 31, 2015, we repurchased $14.4 million of our outstanding 2.25% convertible notes due March 1, 2016 for $14.6 million cash including $0.2 million of accrued interest and recognized a $0.3 million loss on the early extinguishment of the notes.

During the three-month period ended November 30, 2015, we repurchased $9.7 million of our outstanding 2.25% convertible notes due March 1, 2016 for $9.7 million cash and recognized a $0.1 million loss on the early extinguishment of the notes.

On March 1, 2016, we retired the remaining balance of our 2.25% convertible notes at maturity for $26.0 million cash including accrued interest of $0.3 million.

The interest expense associated with convertible notes was as follows:

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 29, 2016

(Unaudited)

(Dollars in millions, except per share amounts)

Note 10 — Derivative Instruments and Hedging Activities

We are exposed to interest rate risk associated with fluctuations in interest rates on our variable rate debt.  Prior to the fourth quarter of fiscal 2015, we utilized two derivative financial instruments to manage our variable interest rate exposure.   We utilized a floating-to-fixed interest rate swap and an interest rate cap agreement with each hedging $50.0 million of notional principal interest under our Revolving Credit Facility.  In connection with the Amendment of our Revolving Credit Facility, we settled our floating-to-fixed interest rate swap and interest rate cap agreements in the fourth quarter of fiscal 2015 for approximately $2.6 million.

Prior to the settlement, the derivative instruments were classified as cash flow hedges with gains and losses on the derivative instruments included in other comprehensive income.  We recognized gains and losses on our derivative instruments as an adjustment to interest expense in the period the hedged interest payment affected earnings.

Note 11 — 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 used the “if-converted” method in calculating the diluted earnings per share effect of the assumed conversion of our contingently convertible debt 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, our 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 excludes income attributable to unvested restricted stock awards from the numerator and excludes 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.

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 29, 2016

(Unaudited)

(Dollars in millions, 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, 2016 and February 28, 2015.

At February 29, 2016 and February 28, 2015, respectively, stock options to purchase 178,490 shares and 169,163 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.

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 29, 2016

(Unaudited)

(Dollars in millions, except per share amounts)

Note 12 — Accumulated Other Comprehensive Loss

Changes in our accumulated other comprehensive loss (“AOCL”) by component for the three- and nine-month periods ended February 29, 2016 and February 28, 2015 were as follows: