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below set forth consolidated sales and gross profit (loss) for our four business segments for each of the last three fiscal years ended May 31.

Business Trends and Highlights

During        In early calendar year 20062008, many U.S. air carriers announced a series of cost reduction initiatives, including staffing reductions, route consolidations and intocapacity reductions. The fleet reductions announced in early 2008 were principally in response to high oil prices. More recent capacity reductions have been in response to the deteriorating U.S. economic environment, including significant declines in fourth quarter 2008 and first quarter 2009 U.S. gross domestic product, and the highest unemployment rate in the U.S. since 1983. Capacity in North America was down approximately 8% during the first calendar quarter of 2007, many2009 compared to last year, and passenger traffic was down approximately 10%. Certain air carriers in the U.S. and abroad have filed for bankruptcy protection, and some have ceased operations. Certain foreign carriers have also reduced capacity in response to weak world-wide economic conditions. A reduction in the global operating fleet of passenger and cargo aircraft has resulted in reduced demand for parts support and maintenance activities for the domestic commercial airlines reported improvedtypes of aircraft affected.

        Disruptions in the financial results, reflectingmarkets, including tightened credit markets, have reduced the amount of liquidity available to certain of our customers which, in turn, affects their ability to implement fare increasesbuy parts, services, engines and aircraft. We continue to partially offset the continued high cost of fuelmonitor economic conditions for their impact on our customers and intense competition. The improvement has also been driven by the airlines’ continued focus on controlling non-fuel related expenses, the implementation of operational efficienciesmarkets, assessing both risks and relatively high load factors.opportunities that may affect our business.

        We expect certainmany carriers will continue to aggressively seek ways to reduce their cost structure, including outsourcing more of their maintenance and support functions to third parties. Further, low-costparties, while we believe other carriers who have historically outsourced their maintenance requirements will continue to expand their presence around the world. Many of these low-cost carriers are flying newer aircraft which will result in increasing demand for maintenance and parts support in future years. Wedo so. Although we believe we remain well positioned to respond to the market with our broad range of products and services, as these trends continuethe factors above may have an adverse impact on our growth rates and our results of operations and financial condition.

        During fiscal 2009, sales to develop.

global defense customers increased 16.8% and at May 31, 2009 represented 42.5% of consolidated sales. We continue to experience strong demand forsee opportunities to provide performance-based logisticlogistics services and mobilitymanufactured products supporting our defense customers’ deployment activities. We are monitoring the debate between the current Administration and the U.S. Congress regarding the troop withdrawal from Iraq and its impact on demand for our products and services.customers' requirements. Although it remains difficult for us to predict long-term demand for these types of products and services, we believe we

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are well positioned with our current portfolio of products and services and growth plans to benefit from longer-term U.S. military deployment and program management strategies.

Results of Operations

Fiscal 20072009 Compared with Fiscal 20062008

(as compared with the same period of the prior year)

Consolidated sales for fiscal 20072009 increased $175,651$39,057 or 19.8%2.8% over the prior year period. Sales to commercial customers decreased 5.5% compared to the prior year reflecting reduced demand for parts support and maintenance activities as a result of declining airline capacity. Sales to commercial customers also declined due to lower sales in our Aircraft Sales and Leasing segment reflecting lower aircraft sales as a result of tight credit markets and reduced demand for big ticket items. Sales to global defense customers increased 16.8% reflecting the favorable impact of acquisitions and strong demand for specialized mobility products and performance-based logistics programs.

        In the Aviation Supply Chain segment, sales decreased $22,525 or 3.7% compared to the prior year. The sales decrease is primarily attributable to reduced demand for parts support from commercial customers as a result of airline capacity reductions, lower sales to a regional airline customer and the unfavorable impact of foreign currency translation. Gross profit in the Aviation Supply Chain segment decreased $14,680 or 10.1% and the gross profit margin percentage decreased to 22.3% from 23.9% in the prior year primarily due to the impairment charge of $10,100 recorded in the fourth quarter of fiscal 2009 (see Note 13 of Notes to Consolidated Financial Statements).

        In the Maintenance, Repair and Overhaul segment, sales increased $46,125 or 15.3% over the prior year. Each reportingThe increase in sales is attributable to the inclusion of revenue from Avborne, which was acquired in March 2008 and contributed approximately $44,000 of revenue during the first nine months of fiscal 2009, as well as increased revenues at our landing gear overhaul business. Sales were lower at our Indianapolis-based MRO facility reflecting reduced demand as a result of airline capacity reductions. Gross profit in the Maintenance, Repair and Overhaul segment increased $7,800 or 17.7%, and the gross profit margin percentage increased slightly to 14.9% from 14.6% in the prior year due primarily to operational improvement initiatives.

        In the Structures and Systems segment, sales increased $88,203 or 22.6% over the prior year. The increase in sales is attributable to the inclusion of revenue from Summa, which was acquired in December 2007, as well as continued strong demand for specialized mobility products and new product offerings. Gross profit in the Structures and Systems segment increased $19,485 or 35.6%, and the gross profit percentage increased to 15.5% from 14.0% in the prior year due to increased volume and increased shipments of higher margin products.

        In the Aircraft Sales and Leasing segment, sales decreased $72,746 or 82.5% compared with the prior year. During the fiscal year ended May 31, 2009, we sold two aircraft from our wholly-owned aircraft portfolio whereas during fiscal 2008, we sold five aircraft from our wholly-owned portfolio. Gross profit (loss) in the Aircraft Sales and Leasing segment decreased $35,062 from the prior year as a result of the reduction in aircraft sales and the impairment charge of $21,033 recorded in the second quarter of fiscal 2009 (see Note 13 of Notes to Consolidated Financial Statements). Earnings from joint ventures increased $2,548 compared to the prior year due to gains on the sale of two aircraft owned in joint ventures.

        Operating income decreased $31,626 or 23.5% compared with the prior year due to the impairment charges and an increase in selling, general and administrative expenses. Selling, general and administrative expenses increased $11,717 primarily as a result of the impact of acquisitions. Net interest expense decreased $1,851 or 9.9% versus the prior year principally due to a reduction in outstanding borrowings and lower interest rates on our revolving credit agreement. Our effective income tax rate decreased to 32.8% compared to 34.8% in the prior year. The decrease in the effective tax rate was due to research and development tax credits recorded during fiscal 2009.

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        During fiscal 2009, we retired $110,510 of convertible notes. The notes were retired for $72,916 cash and the gain after consideration of unamortized debt issuance costs was $35,316 and is reported in gain (loss) on extinguishment of debt on the consolidated statement of operations for fiscal 2009 (see Note 2 of Notes to Consolidated Financial Statements).

        During the second quarter of fiscal 2009, we sold our non-core industrial turbine business, which was classified as a discontinued operation. Loss on the sale of business, net of tax, was $1,403 (see Note 11 of Notes to Consolidated Financial Statements).

        Net income was $78,651 compared to $75,144 in the prior year due to the factors discussed above.

Fiscal 2008 Compared with Fiscal 2007

        Consolidated sales for fiscal 2008 increased $323,750 or 30.5% over fiscal 2007 as all four of our reportable segments experienced an increase in sales. Overall sales growth with saleswas driven by market share gains through solid execution across our business and broad market acceptance of the Company's value proposition of innovative cost savings solutions. Sales to commercial customers increasing 24.3%increased 27.8% and sales to defense customers up 14.4%increased 36.7% compared to the prior year. The sales increase to commercial customers

reflects the improved commercial airline environment, our expanded presence in global markets, growth in supply chain programs, andmarket share gains, increased demand for airframe maintenance and landing gear overhaul, services.strength in supply chain programs, successful marketing efforts in international markets, increased aircraft sales and the impact from acquisitions. Sales to defense customers increased as we continue to experiencereflecting the favorable impact of acquisitions and continued strong demand for performance-based logistics programs and specialized mobility products and the impact from acquisitions.products.

Sales in        In the Aviation Supply Chain segment, sales increased $82,508$62,816 or 17.9%11.6% over the prior year. The sales increase reflects strong demand for engine and airframe parts from commercial customers dueis attributable to improved sourcing and program execution as well as the implementation of new supply chain programs. The increase in sales to defense customers was driven by continued strong demand for parts support from defense-related performance-based logistics programs.programs and aftermarket parts sales to commercial customers. Gross profit in the Aviation Supply Chain segment increased $15,128$30,708 or 15.2%26.8% over the prior year primarily due to increased sales volume, partially offset by an impairment charge of $4,750 recorded in this segment duringand the first quarter of fiscal 2007 (see Note 13 of Notes to Consolidated Financial Statements). The gross profit margin percentage decreased slightlyincreased to 21.0%23.9% from 21.5%21.0% in the prior year due to the unfavorablefavorable mix of products sold and the impairment charge.

In the Maintenance, Repair and Overhaul segment, sales increased $29,258 or 16.1% over the prior year. The increase in sales is primarily attributable to increased demand for landing gear overhaul services as well as airframe maintenance at our Oklahoma and Indianapolis airframe maintenance facilities. Gross profit in the Maintenance, Repair and Overhaul segment increased $4,001 or 15.4% over the prior year due to the increase in sales and the gross profit margin percentage decreased slightly to 14.1% from 14.2%. The gross profit margin improved at our landing gear and Oklahoma airframe maintenance businesses due to increased sales and operational efficiencies. The gross profit margin declined at our Indianapolis airframe maintenance facility due to start-up inefficiencies associated with new customers.

In the Structures and Systems segment, sales increased $35,336 or 15.4% over the prior year. The increase in sales was primarily due to the development and delivery of increasingly complex and specialized shelter products and higher volume of pallets at our Mobility Systems business. Sales also increased due to the inclusion of $12,368 of revenue from Brown which was acquired during the fourth quarter of fiscal 2007 (see Note 11 of Notes to Consolidated Financial Statements). Sales of our cargo systems were lower as we relocated production to a new manufacturing facility in North Carolina. Gross profit in the Structures and Systems segment increased $2,310 or 6.9% compared to the prior year due to the increase in sales. The gross profit margin percentage decreased from 14.7% to 13.6% due to the unfavorable mix of products sold, primarily at our Mobility Systems business.

In the Aircraft Sales and Leasing segment, sales increased $28,549 due to more aircraft sales compared to the prior year. During fiscal 2007, our joint ventures purchased six aircraft and sold ten. The increase in earnings from aircraft joint ventures compared to the prior year is primarily due to the sale of the ten aircraft. At May 31, 2007, the total number of aircraft held in joint ventures was 12 (see Note 7 of Notes to Consolidated Financial Statements). Our strategy in the Aircraft Sales and Leasing segment is to build an aircraft portfolio through participation in joint ventures and for our own account. We also own nine aircraft outside of the joint ventures. Of the nine aircraft owned by us outside the aircraft joint ventures, five were acquired prior to September 11, 2001. Gross profit in the Aircraft Sales and Leasing segment decreased $513 compared to the prior year principally due to the$4,750 impairment charge of $2,902 recorded during the first quarter of fiscal 2007 (see Note 13 of Notes to Consolidated Financial Statements).

In the Maintenance, Repair and Overhaul segment, sales increased $89,355 or 42.2% over the prior year. The increase in sales is primarily attributable to increased revenue at the Indianapolis heavy maintenance facility, greater volume of landing gear overhauls and the inclusion of revenue from Avborne which was acquired in March 2008 and contributed approximately $16,000 of revenues during fiscal 2008 (see Note 7 of Notes to Consolidated Financial Statements). Gross profit in the Maintenance, Repair and Overhaul segment increased $14,052 or 47.0%, and the gross profit percentage increased to 14.6% from 14.1% in the prior year due to increased volume and operational improvement initiatives.

        In the Structures and Systems segment, sales increased $125,345 or 47.5% over the prior year. The sales increase is attributable to sustained high levels of demand and new business wins for specialized mobility products, and the inclusion of revenue from Brown (acquired in April 2007) and Summa (acquired in December 2007) which together contributed approximately $88,800 of revenues during fiscal 2008 (see Note 7 of Notes to Consolidated Financial Statements). Gross profit in the Structures and Systems segment increased $18,652 or 51.8% compared to the prior year primarily due to increased sales, while the gross profit margin percentage increased slightly to 14.0% from 13.6%.

        In the Aircraft Sales and Leasing segment, sales increased $46,234 or 110.4% compared with the same period last year driven by the sale of five aircraft from our wholly-owned portfolio. Gross profit in the Aircraft Sales and Leasing segment increased $16,513 as a result of increased aircraft sales and the $2,902 impairment charge recorded during the first quarter of fiscal 2007 we recorded an impairment charge of $4,750 in the Aviation Supply Chain segment for engine parts that were acquired prior to September 11, 2001, and were subject to impairment charges recorded in prior years. This impairment charge was triggered by our decision to aggressively pursue the liquidation of this inventory. We made this decision to recognize the impairment due to the impact of persistently high fuel costs and fewer operators on demand for these parts, as well as

to better align human and physical resources with higher potential opportunities in the rapidly growing Aviation Supply Chain segment (see Note 13 of Notes to Consolidated Financial Statements). InUp until mid fiscal 2008, our strategy in the Aircraft Sales and Leasing segment was to invest in aircraft mostly through participation in joint ventures and for our own account. During fiscal

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2008, we recorded an impairment chargepurchased 20 aircraft with joint venture partners, all of $2,902 duringwhich are currently on lease. At May 31, 2008, the first quartertotal number of 2007 on a wide-body aircraft originally purchasedheld in joint ventures was 29 (see Note 8 of Notes to Consolidated Financial Statements). Earnings from joint ventures declined $5,004 as aircraft joint ventures had less sales activity in fiscal 2008 compared to fiscal 2007. We also owned eight aircraft outside of the joint ventures. Of the eight aircraft owned by us outside the aircraft joint ventures, four were acquired prior to September 11, 2001. The lease and non-recourse debt on the aircraft were restructured during the quarter, and we made the decision to offer the aircraft for sale and recorded the impairment charge to reduce the carrying value of the aircraft to estimated net realizable value. As part of the restructuring, the lender of the non-recourse debt reduced the outstanding principal balance by $2,927 which resulted in a gain on extinguishment of the same amount.

During the first quarter of fiscal 2007, we sold substantially all assets, subject to certain liabilities, of a product line within our Structures and Systems segment. Proceeds from the sale of the product line were $6,567 and the net carrying value of the assets sold was $1,209, resulting in a gain on sale of product line of $5,358. The gain on this transaction has been classified as a component of operating income in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.

Operating income increased $30,194$39,152 or 46.3%41.1% compared withto the prior year’ssame period last year due to increased sales increased earnings from aircraft joint ventures and the gain on the sale of a product line,gross profit, partially offset by impairment charges and an increase in selling, general and administrative expenses. In fiscal 2007, our selling,Selling, general and administrative expenses increased $5,540 or 5.6% over$30,411 reflecting the prior year primarily due toimpact of acquisitions, increased resourcesspending to support our growth. Selling, generalgrowth and administrative expensesinvestments in operational improvement initiatives. Interest expense increased $3,877 as a percentageresult of sales decreased to 9.9% compared to 11.2%an increase in the prior year. Interest expense decreased $1,303 or 7.2% primarily due to a reduction in average outstanding borrowings onunder our unsecured revolving credit agreements during fiscal 2007,facility to support growth, as well as capitalized interest of $977.an increase in non-recourse borrowings to acquire aircraft. Interest income and other increased $2,593 or 80.1% due to higher averagedecreased $3,093 principally as a result of lower yields on invested cash, during the current fiscal year, as well as a $915 gain on sale of an equity security.decline in average invested cash balances. Our effective income tax rate for fiscal 2007 was 32.0%increased to 34.8% compared to 23.0%32.0% in the prior year due to lowerthe expiration of certain income tax benefits on export activities. We expect our effective income tax rate to be approximately 35% in fiscal 2008.

During the third quarter of fiscal 2007, we decided to exit our non-core industrial turbine business, which was part of the Structures and Systems segment, and classified the results as a discontinued operation. Sales for thisDuring the second quarter of fiscal 2009, we sold our non-core industrial turbine business. Loss on the sale of business, were $7,778 in fiscal 2007.net of tax, was $1,403 (see Note 11 of Notes to Consolidated Financial Statements).

Net income increasedwas $75,144 compared to $58,660 for fiscal 2007 compared to $35,163 in the prior year due to the factors discussed above.

Fiscal 2006 Compared with Fiscal 2005

Consolidated sales for fiscal 2006 increased $145,091 or 19.6% over the prior year. The increase in sales over the prior year was attributable to sales increases in the Aviation Supply Chain; Maintenance, Repair and Overhaul and Structures and Systems segments due to an 18.8% increase in sales to commercial airline customers and a 21.7% increase in sales to defense customers. The increase in sales to commercial airline customers principally reflects improved demand for engine and airframe parts support due to increased passenger traffic, improved sourcing and program execution. Sales to commercial customers also increased as a result of a full year of revenue during fiscal 2006 at the Indianapolis airframe maintenance facility, compared to only four full months during fiscal 2005, as that facility commenced operations in January 2005. The increase in sales to defense customers was principally driven by continued strong demand for specialized mobility products and new performance-based logistics programs. Consolidated gross profit increased $42,646 or 35.4% over the prior year. The increase in gross profit was attributable to the consolidated sales increase, as well as an improvement in the consolidated gross margin percentage to 18.4% from 16.3% in the prior year.

Sales in the Aviation Supply Chain segment increased $71,106 or 18.2% compared to the prior year. The sales increase reflects increased demand for engine and airframe parts to commercial customers as well as an increase in sales to program customers using our supply chain management programs. The increase in sales to defense customers served by this segment was driven by continued strong demand for parts support from existing and new performance-based logistics programs. Gross profit in the Aviation Supply Chain segment increased $31,583 or 46.7% over the prior year primarily due to increased sales volume as well as an improvement in the gross profit margin percentage to 21.5% from 17.3% in the prior year. The improvement in the gross profit margin percentage was attributable to effective purchasing and favorable mix of products sold.

In the Maintenance, Repair and Overhaul segment, sales increased $70,326 or 62.8% over the prior year. The increase in sales was primarily attributable to a full year of revenue at our Indianapolis airframe maintenance facility during fiscal 2006, compared with only four full months of sales during fiscal 2005, as that facility commenced operations in January 2005. Sales also increased over the prior year at our Oklahoma City airframe maintenance facility and landing gear overhaul center reflecting stronger demand. Gross profit in the Maintenance, Repair and Overhaul segment increased $11,500 or 79.8% over the prior year and the gross profit margin percentage improved from 12.9% to 14.2%, primarily due to improvements at our Oklahoma City-based airframe maintenance facility and the favorable impact of a full year of operations at the Indianapolis airframe maintenance facility.

In the Structures and Systems segment, sales increased $35,451 or 18.3% over the prior year as we experienced increased sales at all of our business units within the segment. The increase was primarily attributable to increased sales of products supporting our defense customers’ deployment activities due to continued strong demand and new product development, and increased demand for cargo systems and composite structure products primarily due to successful sales and marketing efforts. Gross profit in the Structures and Systems segment declined $1,473 or 4.2% compared to the prior year as the gross profit margin percentage decreased from 18.2% to 14.7% primarily due to the unfavorable mix of products sold.

In the Aircraft Sales and Leasing segment, sales decreased $31,792 or 70.4% compared with the prior year. The decrease in sales is principally due to the fact that the majority of current year aircraft activity is conducted through unconsolidated joint ventures, which excludes revenues from consolidated net sales. Since September 11, 2001, most of the aircraft transactions we have entered into have been with joint venture partners who provide equity capital equal to our equity capital contribution. Debt is provided on a limited recourse basis by various financial institutions. Gross profit in the Aircraft Sales and Leasing segment increased $1,036 or 31.3% compared to the prior year.

Operating income increased $30,255 or 86.6% compared with the prior year due to increased gross profit, partially offset by an increase in selling, general and administrative expenses. During fiscal 2006, selling, general and administrative expenses increased $13,325 or 15.5% primarily due to increased resources to support our growth. Net interest expense declined $647 compared to the prior year primarily due to increased interest income as a result of higher average invested cash balances during fiscal 2006 compared with the prior year.

During the third quarter of fiscal 2006, we acquired $50,645 aggregate principal amount of our 2.875% Convertible Senior Notes due 2024, or approximately 76% of the previously outstanding principal amount, in exchange for an aggregate 2,724 newly issued shares of common stock plus $3,893 in cash, in privately negotiated transactions exempt from the registration requirements under the Securities Act of 1933, as amended. The number of shares issued was equivalent to the number into which the notes were convertible under the original terms of the notes. We recorded $3,893 of pre-tax expense on the exchange of the notes into stock in advance of the call date which was comprised of interest that the note holders would otherwise have been entitled to receive as well as an incentive payment made as part of the exchange.

Also during the third quarter of fiscal 2006, upon completion of our fiscal 2005 Federal income tax return, we determined that the Company qualified for additional tax benefits of $1,606 related to higher than estimated margin on fiscal 2005 export activities. We recorded a benefit of $496 related to fiscal 2004 export activity in the third quarter of 2005. Our effective income tax rate for fiscal 2006 was 23.0% compared to 15.5% in the prior year.

Income from continuing operations increased to $35,823 compared to $19,498 in the prior year due to the factors discussed above.

During the third quarter of fiscal 2005, we sold our engine component repair business located in Windsor, Connecticut, and during the third quarter of fiscal 2007, we decided to exit our non-core industrial turbine business. As a result, we have classified the results of these businesses as discontinued operations for all periods presented.

Net income increased to $35,163 for fiscal 2006 compared to $15,453 in the prior year due to the factors discussed above.

Legal Matters

AAR Manufacturing, Inc., a subsidiary of the Company (“subsidiary”("subsidiary") received an Administrative Order for Response Activity (“Order”("Order") dated August 7, 2003, from the Michigan Department of Environmental Quality (“MDEQ”("MDEQ") relating to environmental conditions at and in the vicinity of the subsidiary’ssubsidiary's Cadillac, Michigan plant. The Order requiresrequired the subsidiary to perform environmental investigatory work, prepare a feasibility study and a remedial action plan, and perform interim response actions. The interim response actions include continuation of the response activities the subsidiary is performing under a 1985 Consent Decree, operation of a soil vapor extraction system the subsidiary had previously installed and operated, determination of the need to provide alternate water supplies to off-site properties (and if it is so determined then to actually provide them), removal of any free phase liquids encountered in the ground, providing notices of groundwater contamination migration to off-site property owners, and other actions determined by the MDEQ or the subsidiary to be appropriate. The MDEQ further demands payment of environmental response costs already incurred by the MDEQ in the approximate amount of $2,500 plus interest, and reimbursement of unspecified costs to be incurred in the future by the MDEQ. The Order and the letter accompanying it threaten the imposition of civil fines up to $25 for each day of violation of the Order, plus exemplary damages up to three times the costs incurred by the MDEQ if the subsidiary does not comply with the Order. The Order may require the implementation of the remedial action plan, although it is not clear on that point. The Order requires the implementation of emergency response action if a release of hazardous substances, threat of a release, or exacerbation of existing contamination occurs during the pendency of the Order.

The subsidiary advised the MDEQ that it would perform the requirements of the Order to the extent those requirements apply to the allegation by the MDEQ that a release of hazardous substances occurred after the execution of the 1985 Consent Decree. The subsidiary declined to perform certain work required by the Order that the subsidiary believes is based on claims resolved in the 1985 Consent Decree. The MDEQ responded to the subsidiary by saying that the MDEQ “will be taking appropriate action to protect public health, safety and welfare and the environment, and gain AAR’s compliance with Part 201” (the Michigan “cleanup law”).

The subsidiary has received funds from an insurance carrier to reimburse it for a portion of the subsidiary’s costs. The subsidiary sought coverage from another insurance company and that carrier is paying a portion of defense costs, but has reserved its rights on coverage for the litigation noted below. The subsidiary has filed suit against one of the insurance carriers for breach of contract and other relief and recently reached a settlement.

Prior to the issuance of the Order, the subsidiary sought a Court order to enforce the 1985 Consent Decree, but that relief was denied by the Court, primarily on the basis that the action was premature since the State was not pursuing an enforcement action at the time. The subsidiary sought leave to appeal that decision to the Michigan Court of Appeals, but leave was denied.

The work performed and data gathered by the subsidiary since the issuance of the Order appears to support the positions previously taken by the subsidiary regarding the movement of groundwater for treatment by the subsidiary. There is disagreement with the MDEQ regarding the conclusions to be drawn from the data developed from that work. The MDEQ has retained contractors to perform environmental investigations in the vicinity of the plant.

On March 31, 2005, a complaint was filed by the MDEQ in Cadillac, Michigan with the Wexford County Circuit Court. The case isMichigan Department of Environmental Quality vvs AAR Cadillac Manufacturing, a division of AAR Manufacturing Group, Inc., an Illinois corporation, and AAR Corp., a

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Delaware corporation, File No. 05-18853-CE.05-18853-CE. In its complaint, the MDEQ seeks to enforce the Order against the subsidiary and to have the Court impose civil fines and exemplary damages upon the subsidiary for the alleged failure to comply with the Order. The MDEQ seeks to recover its costs incurred in performing response activities from both the subsidiary and the Company and seeks a declaratory judgment that both are liable for all future costs incurred by the State at the facility. The MDEQ also seeks civil fines from the subsidiary for alleged violations of a particular section of a Michigan environmental law.

The Company and the subsidiary filed their Answer, including Affirmative Defenses, and intend on vigorously defendingaffirmative defenses. Prior to trial, the complaint filedcourt granted a motion by the MDEQ. On June 17, 2005,Company to dismiss the Company as a defendant, leaving the subsidiary as the only remaining defendant in the lawsuit.

        Trial took place during the months of December 2008 through February 2009. During the trial, the court granted a motion by the subsidiary to dismiss MDEQ's claims for enforcement of the Order and for civil fines and exemplary damages for the Company's alleged failure to comply with the Order. As a result of this ruling, the only issues remaining in the case are whether the subsidiary is liable for a post-Consent Decree release of contamination and, if so, what costs MDEQ is entitled to recover. The court also filedruled that it would bifurcate the trial between liability and cost recovery. The first stage of trial was devoted to liability. If the court finds the subsidiary liable, it will move to the second stage of determining what costs are owed by the subsidiary. At the close of trial in February 2009, the court asked the parties to submit post-trial briefs, which have now been completed. The court currently has the case under consideration and will issue a Petition for Reimbursement of itsruling on liability.

        In a related matter, in December 2008, the Company and the subsidiary were sued by Liberty Mutual Insurance Co., the insurer who had been paying the Company's defense costs in the amountMDEQ matter. The suit, entitledLiberty Mutual Insurance Company vs AAR Corporation, AAR Manufacturing Inc. and AAR Cadillac Manufacturing (No. 08 CH 46851) was filed in the Circuit Court of approximately $200 incurred in complying withCook County, Chancery Division. Plaintiff Liberty Mutual seeks a declaratory judgment stating that it has no duty to defend or indemnify the Order from the State of Michigan cleanup and redevelopment fund established under Michigan law, plus costs and attorney fees. As of May 31, 2007,Company or the subsidiary has chargedwith respect to operations $1,309 related to thisthe MDEQ matter. The MDEQcase remains pending and discovery has filed a motion for summary disposition which is scheduled for an August 20, 2007 hearing.not yet begun.

In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial condition or results of operations.

Liquidity and Capital Resources

Historically, we have funded our operating activities and met our commitments through the generation of cash from operations, augmented by the periodic issuance of common stock and debt in the public and private markets. In addition to these cash sources, our current capital resources include our unsecured credit facility. We continually evaluate various financing arrangements, including the issuance of common stock or debt, which would allow us to improve our liquidity position and finance future growth on commercially reasonable terms. Our continuing ability to borrow from our lenders and issue debt and equity securities to the public and private markets in the future may be negatively affected by a number of factors, including the overall health of the credit markets, general economic conditions, airline and aviation industry conditions, geo-political events, including the war on terrorism, and our operating performance. Our ability to generate cash from operations is influenced primarily by our operating performance and changes in working capital. We haveUnder a universal shelf registration on filestatement filed with the Securities and Exchange Commission under which, subject to market conditions,that became effective on December 12, 2008, we may offer and sell up to $163,675$300,000 of various types of securities, including common stock, preferred stock or medium-and medium-term or long-term debt securities, may be issued or sold.subject to market conditions.

At May 31, 2007,2009, our liquidity and capital resources included cash of $83,317$112,505 and working capital of $389,215. On August 31, 2006, we entered into a$596,894. Our revolving credit agreement, as amended (the "Credit Agreement") with various financial institutions, as lenders, and Bank of America National Association as successor by merger to LaSalle Bank

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National Association ("Bank of America"), as administrative agent for the lenders, (the “LaSalle Credit Agreement”). The LaSalle Credit Agreement created a $140,000provides us with unsecured revolving credit facility that we can draw upon for general corporate purposes.borrowing capacity of up to $250,000. Under certain circumstances, we may request an increase to the revolving commitment by an aggregate amount of up to $35,000,$75,000, not to exceed $175,000$325,000 in

total. The LaSalleterm of our Credit Agreement expires onextends to August 31, 2010.2011. Borrowings under the LaSalle Credit Agreement bear interest at the London Interbank Offered Rate (“LIBOR”("LIBOR") plus 125100 to 200237.5 basis points based on certain financial measurements. There were no borrowingsBorrowings outstanding under this facility at May 31, 2007. On August 31, 2006, we terminated our secured revolving2009 were $50,000, and there were approximately $12,910 of outstanding letters of credit agreement with Merrill Lynch Capital and duringwhich reduced the second quarteravailability of fiscal 2007, we terminated our accounts receivable securitization program. No borrowings were outstanding and no accounts receivable were sold at the date of these terminations. No material penalties or fees resulted from the terminations.this facility. In addition to our domestic facility,Credit Agreement, we also have $3,041$3,169 available under a foreign line of credit.

We continually evaluate various financing arrangements, including the issuance of common stock or debt, that would allow us to improve our liquidity position and finance future growth on commercially reasonable terms. Our ability to obtain additional financing is dependent upon a number of factors, including the geo-political environment, general economic conditions, airline industry conditions, our operating performance and market conditions in the public and private debt and equity markets.

During the year ended May 31, 2007, we used $21,239 offiscal 2009, cash flow from operations was $64,451 primarily dueas a result of net income and depreciation of $119,202, partially offset by an increase in inventories of $45,414 principally reflecting investments to investments of $67,750 made in aircraftsupport our Aviation Supply Chain customers, and engines on both short- and long-term lease, a $25,160an increase in accounts receivable reflecting higher sales, payment of capitalized program development costs of $17,023 related to the A400M program which is reported in other on the consolidated statements of cash flows, and investment in inventories of $8,567.$26,388.

        During fiscal 2007, cash flow from operations benefited from an increase in accounts payable of $6,473 as well as net income and depreciation and amortization of $90,859.

During the year ended May 31, 2007,2009, our investing activities used $39,129$24,227 of cash principally as a result of capital expenditures of $29,891, acquisitions of $38,478 (see Note 11 of Notes to Consolidated Financial Statements)$27,535, which mainly represents capacity expansion and investmentcapability improvements in our Structures and Systems and Maintenance, Repair and Overhaul segments, partially offset by proceeds from aircraft joint ventures of $9,556, partially offset by cash generated from the sales of$4,230. We expect fiscal 2010 capital expenditures to be $25,000 to $30,000, principally reflecting increased investments across our interests in aircraft joint ventures of $32,108Maintenance, Repair and proceeds from the sale of a product line of $6,567 (see Note 12 of Notes to Consolidated Financial Statements).Overhaul and Structures and Systems segments.

During the year ended May 31, 2007, cash generated fromfiscal 2009, our financing activities was $21,973, comprised principallyused $36,167 of proceeds from borrowings relatedcash primarily due to aircraft financings of $30,355, cash proceeds from stock option exercises of $8,576 and excess tax benefits from the exercise of stock options of $4,345, partially offset by a reduction in borrowings of $20,439,$110,625, which includes $9,034 for the early retirement of 6.875% Notes due December 15, 2007.convertible notes for $72,916 cash and the paydown of our revolving credit facility of $25,000. Proceeds from borrowings of $75,323 during fiscal 2009 principally reflects proceeds from our revolving credit facility.

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Contractual Obligations and Off-Balance Sheet Arrangements

A summary of contractual obligations and off-balance sheet arrangements as of May 31, 20072009 is as follows:

Notes:

¹

$119,721 of our long-term debt is due February 1, 2026; however, we may redeem for cash all or a portion of the notes at any time on or after February 6, 2013. Holders of the notes have the right to require us to purchase all or a portion of notes on February 1, 2013, 2016 and 2021. See Note 2 of Notes to Consolidated Financial Statements.

²

The term of our revolving credit agreement extends to August 31, 2011.

³

Interest associated with variable rate debt was determined using the interest rate in effect on May 31, 2009.

Purchase obligations arise in the ordinary course of business and represent a binding commitment to acquire inventory, including raw materials, parts and components, as well as equipment to support the operations of our business. We routinely issue letters of credit and performance bonds in the ordinary course of business. These instruments are typically issued in conjunction with insurance contracts or other business requirements. The total of these instruments outstanding at May 31, 20072009 was approximately $11,891.$12,910.

Critical Accounting Policies and Significant Estimates

Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States. Management has made estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities to prepare the consolidated financial statements. The most significant estimates made by management include those related to the allowance for doubtful accounts, assumptions used in assessing goodwill impairment, adjustments to reduce the value of inventories and aviation equipment on or available for lease, allowance for doubtful accounts, revenue recognition, loss accruals for aviation equipment operating leases, program development costs and assumptions used in determining pension plan obligations. Accordingly, actual results could differ materially from those estimates. The following is a summary of the accounting policies considered critical by management.

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Allowance for Doubtful Accounts

Our allowance for doubtful accounts is intended to reduce the value of customer accounts receivable to amounts expected to be collected. In determining the required allowance, we consider factors such as general and industry-specific economic conditions, customer credit history, and the customer’sour customer's current and expected future financial performance.

InventoriesGoodwill

        Under Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," goodwill and other intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment tests. The Company reviews and evaluates its goodwill and indefinite life intangible assets for potential impairment at a minimum annually, on May 31, or more frequently if circumstances indicate that impairment is possible. We use a two step process to evaluate goodwill for impairment. In the first step, we compare the fair value of each reporting unit with the carrying value of the reporting unit, including goodwill. We estimate the fair value of each reporting unit using a valuation technique based on a multiple of earnings or discounted cash flows. If the estimated fair value of the reporting unit is less than the carrying value of the reporting unit, we would be required to complete a second step to determine the amount of goodwill impairment. In the second step, we would determine an implied fair value of the reporting unit's goodwill by allocating the reporting unit's fair value to all of the assets and liabilities other than goodwill. We then would compare the implied fair value of goodwill to the carrying amount and recognize the difference as an impairment charge.

        The assumptions we used to estimate fair value of the reporting unit are based on historical performance as well as forecasts used in our current business plan.

        The amount reported under the caption "Goodwill and other intangible assets, net" is comprised of goodwill and intangible assets associated with acquisitions we made, principally since the beginning of fiscal 1998.

Inventories

Inventories are valued at the lower of cost or market. Cost is determined by the specific identification, average cost or first-in, first-out methods. Provisions are made for excess and obsolete inventories and inventories that have been impaired as a result of industry conditions. We have utilized certain

assumptions when determining the market value of inventories, such as historical sales of inventory, current and expected future aviation usage trends, replacement values and expected future demand. During the first quarter of fiscal 2007, we recorded an impairment charge related to certain engine parts in the amount of $4,750. These parts were acquired prior to September 11, 2001, and were subject to impairment charges recorded in fiscal 2002 and 2003. The fiscal 2007 impairment charge was triggered by the Company’s decision to aggressively pursue the liquidation of this inventory. The Company made this decision to recognize the impairment due to the impact of persistently high fuel costs and fewer operators on demand for these parts, as well as to better align human and physical resources with higher potential opportunities in the rapidly growing Aviation Supply Chain segment. Reductions in demand for certain of our inventories or declining market values, as well as differences between actual results and the assumptions utilized by us when determining the market value of our inventories, could result in additionalthe recognition of impairment charges in future periods.

        During the fourth quarter of fiscal 2009, we recorded a $10,100 pre-tax impairment charge on inventory and engines which had been acquired prior to September 11, 2001. This inventory was also subject to impairment charges recorded in previous fiscal years. The fiscal 2009 impairment charge was triggered by declining conditions in the commercial aviation industry and a slowdown in the sales volume of these assets during the fiscal year (see Note 13 of Notes to Consolidated Financial Statements).

Revenue Recognition

Certain supply chain management programs that 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. In connection with these programs, we are required to make certain judgments and