AAR CORP. and Subsidiaries

Quarterly Report on Form 10-Q

For the Quarter Ended August 31,November 30, 2004

Table of Contents

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AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of August 31,November 30, 2004 and May 31, 2004

(In thousands)

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 Six Months Ended August 31,November 30, 2004 and 2003

(Unaudited)

(In thousands except per share data)

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 ThreeSix Months Ended August 31,November 30, 2004 and 2003

(Unaudited)

(In thousands)

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 Three and Six Months Ended August 31,November 30, 2004 and 2003

(Unaudited)

(In thousands)

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
August 31,

November 30, 2004

(Unaudited)

(In thousands)

Note A – 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, 2004 has been derived from audited financial statements.  To prepare the financial statements in conformity with accounting principles generally accepted in the United States of America, 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 accounting principles generally accepted in the United States, 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 August 31,November 30, 2004 and the condensed consolidated results of operations cash flows and comprehensive income for the three-monththree- and six-month periods ended August 31,November 30, 2004 and 2003, and the condensed consolidated cash flows for the six-month periods ended November 30, 2004 and 2003.  The results of operations for such interim periods are not necessarily indicative of the results for the full year.

Note B – Income Taxes

During the second quarter of fiscal 2005 ending November 30, 2004, we recorded a favorable federal income tax adjustment of $1,575 or $0.05 per share.  In October 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law.  The Act included a number of federal income tax reforms, including an extension of the foreign tax credit carryforward period from five years to ten years.  In previous fiscal years, we had established a deferred tax valuation allowance of $1,575 against foreign tax credits expiring in fiscal year 2006.  As a result of the new ten-year carryforward period established by the Act, we now expect to utilize the foreign tax credits and recorded a $1,575 credit to the provision for income taxes during the second quarter of fiscal 2005.

Note C – Stock-Based Employee Compensation Plans

We have an employee stock option plan which we account for under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations.  No stock-based employee compensation cost related to our stock option plan is reflected in net income, as each option granted under this plan had an exercise price equal to the market value of the underlying common stock on the date of grant.

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The following table illustrates the effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of Statement of Accounting Financial Standards (“SFAS”) No. 123 to the Company’s stock option plans (in thousands, except per share amounts).

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in the threesix months ended August 31,November 30, 2004 and 2003:

Note CD – New Accounting Standards

In JuneNovember 2004, the Emerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board (“FASB”) reached a tentative conclusion with respect to Issue No. 04-8, “The Effect of Contingently Convertible DebtInstruments on Diluted Earnings Perper Share.”  The tentative conclusionEITF 04-8 requires companies to account for contingently convertible debt using the “if converted” method set forth in SFAS No. 128 “Earnings Perper Share,” for calculating diluted earnings per share.  Contingently convertible debt wouldis to be included in diluted earnings per share as if the debt had been converted into common stock.  If adopted in its current form,The provisions of EITF 04-08 are required to be applied to reporting periods ending after December 15, 2004.  Based on the applicationprovisions of this standard may result in a reductionEITF 04-8, the inclusion of shares related to our contingently convertible debt would not have had an effect on diluted earnings per share.share for the second quarter of fiscal 2005 and is not expected to have a material effect on earnings per share during the third and fourth quarters of fiscal 2005.  Based on our current capital structure, earnings of approximately $0.18 per share per quarter are required before the inclusion of shares related to our contingently convertible debt would negatively impact diluted earnings per share by $0.01.

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In December 2004, the FASB issued SFAS No. 123 (revised 2004) “Share-Based Payment” (“SFAS 123(R)”).  SFAS 123(R) addresses the accounting for transactions in which an enterprise exchanges its equity instruments for employee services.  It also addresses transactions in which an enterprise incurs liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of those equity instruments in exchange for employee services.  For public entities, the cost of employee services received in exchange for equity instruments, including employee stock options, is to be measured on the grant-date fair value of those instruments.  That cost will be recognized as compensation expense over the service period, which would normally be the vesting period.  SFAS 123(R) is effective as of the first interim or annual reporting period that begins after June 15, 2005.  We will adopt the provisions of SFAS 123(R) in the second quarter of fiscal 2006 and anticipate that adoption of the standard will result in approximately $1,500 of pre-tax compensation expense in fiscal 2006 for current unvested stock options.

Note DE – 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.  Service revenues 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, the serviced units are typically shipped to the customer immediately upon completion of the related services.  Sales and related cost of sales for certain long-term manufacturing contracts and for certain large airframe maintenance contracts are recognized by the percentage of completion method, based on the relationship of costs incurred to date to estimated total costs under the respective contracts.  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

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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.

Note E – Interest Expense

During the first quarter, we retired $6,890 of 6.875% notes payable due in December 2007 and $8,000 of 2.875% convertible notes due in February 2024.  The notes were repurchased for $13,638, and we charged $257 of related capitalized financing costs to operations, resulting in a net gain of $995.

In April 2004, we received an unfavorable court ruling pertaining to a counterclaim for damages filed by us for a breach of contract by the lessee of one of our aircraft engines.  The court’s ruling obligated us to return funds we had drawn on a letter of credit posted by the lessee, plus interest.  As a result of the court’s ruling, we increased our reserve for this matter by $1,600 during the third quarter of fiscal 2004.  In August 2004, the court issued its ruling with respect to the interest component of the award.  As a result we increased our reserve by $500 for additional interest expense during the first quarter of fiscal 2005.

The net effect of the net gain on the repurchase of the notes for $995 and the $500 additional interest expense pertaining to the judgment was a reduction to interest expense of $495 during the first quarter of fiscal 2005.

Note F – Inventory

The summary of inventories is as follows:

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Note G –Joint Ventures

During the first quarter of fiscal 2005 ending August 31, 2004, we entered intoinvested in a limited liability company, and a joint venture with separate partners.  Our investment in the limited liability companywhich is accounted for under the equity method of accounting.  We consolidateOur investment in the financial position and results of operations of the joint venture.

In June 2004, we entered intolimited liability company was made under an agreement with a global financial institution establishing a limited liability company.institution.  Our equitymembership interest in this limited liability company is 50% and the primary business of this company is the acquisition, ownership, lease and disposition of certain narrow-body commercial aircraft.  Aircraft that are acquired by the company are purchased with cash contributions by the members of the company, and debt financing which is non-recourse to the members of the company.  Our investment in this company is accounted for under the equity method of accounting.

During the first quarter, the limited liability company acquired one aircraft on lease to a foreign carrier.  The total  Total assets and debt of the limited liability company at August 31,November 30, 2004 were $8,007$7,794 and $5,204,$4,992, respectively.  Our equity investment in this company is $1,401 at August 31,November 30, 2004.

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In addition to the aforementioned limited liability company, duringDuring the first quarter of fiscal 2005 ending August 31, 2004, we along with a different partner, formedalso invested in a joint venture company whichwith a different party.  The joint venture company owns an aircraft on lease to a foreign carrier.  This aircraft is subject to a note payable to a major financial institution whichthat is guaranteed by AAR.  Our equity interest in this joint venture company is 50%.  As a result of our guarantee of the debt, we consolidate the financial position and results of operations of this company.  The equity interest of the other partner in the joint venture is recorded as a minority interest, which was included in other non-current liabilities at November 30, 2004.

Note H – Supplemental Cash Flows Information

Non-cash operating and financing activities relating to the consolidation of the joint venture company were as follows during the quartersix-month period ended August 31,November 30, 2004:

Note H – Supplemental Cash Flows Information11

Note I – Common Stock and Earnings per Share of Common Stock

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.  The following table provides a reconciliation of the computations of basic and diluted earnings per share information for the three-monththree- and six-month periods ended August 31,November 30, 2004 and 2003.

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At August 31,November 30, 2004 and 2003, respectively, stock options to purchase 3,2213,139 and 5,7145,650 shares of common stock were outstanding, but were not included in the computation of diluted earnings per share, because the exercise price of these options was greater than the average market price of the common shares.shares during the interim periods then ended.

For the three-monthsix-month period ending August 31,November 30, 2003, common stock equivalents representing options to purchase 1589 shares were not included in the computationscomputation of diluted earnings per share because to do so would have been antidilutive due to the net loss during the period.

As of August 31,November 30, 2004, we had $67,000 of convertible senior notes outstanding.  The notes were issued in February 2004 and are due February 1, 2024 unless earlier redeemed, repurchased or converted, and bear interest at 2.875% payable semiannually on February 1 and August 1.

The notes are convertible into shares of AAR common stock based on a conversion rate of 53.7924 shares per $1,000 principal amount of notes, which is equivalent to an initial conversion price of approximately $18.59 per share, under the following circumstances: (i) on any business day up to the maturity date, if the closing sale price of our common stock for at least 20 trading days in the 30 consecutive trading day

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period ending on the eleventh trading day of any fiscal quarter is greater than 120% of the applicable conversion price on the eleventh trading day of that quarter; (ii) at any time after February 1, 2019, if the closing price of AAR common stock on any trading day after February 1, 2019, is greater than 120% of the then applicable conversion price; (iii) at any time until February 1, 2019, during the five consecutive business day period in which the trading price for a note for each day of that trading period was less than 98% of the closing sale price of our common stock on such corresponding trading day multiplied by the applicationapplicable conversion rate; (iv) we call the notes for redemption; (v) during any period in which the credit rating assigned to our long-term senior debt by Moody’s Investor Services is below Caa1 and by Standard & Poor’s Rating Services is below B, the credit rating assigned to our long-term senior debt is suspended or withdrawn by both such rating agencies, or neither rating agency is rating our long-term senior debt; or (vi) specified corporate transactions occur.

We may redeem for cash all or a portion of the notes at any time on or after February 1, 2008 at specified redemption prices.  Holders of the notes have the right to require us to repurchase in cash all or any portion of the notes on February 1, 2010, 2014 and 2019.  In each case, the repurchase price payable will be equal to 100% of the principal amount of the notes to be repurchased, plus accrued interest and unpaid interest and liquidated damages, if any, to, but not including, the date of repurchase.

The numbers of shares potentially convertible is 3,604, and are not included in diluted earnings per share as of August 31,November 30, 2004, as they have not met the requirements of conversion.conversion (see Note D).

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Note J – Impairment Charges

The components of the fiscal 2003 and fiscal 2002 impairment charges were as follows:

Prior to September 11, 2001 we were executing our plan to reduce our investment in support of older generation aircraft in line with

the commercial airlines’ scheduled retirement plans for these aircraft.  The events of September 11 caused a severe and sudden disruption in the commercial airline industry, which brought about a rapid acceleration of those retirement plans.  System-wide capacity was reduced by approximately 20%, and many airlines cancelled or deferred new aircraft deliveries.  Based on management’s assessment of these and other conditions, in the second quarter ended November 30, 2001, we reduced the value and provided loss accruals for certain of our inventories and engine leases which support older generation aircraft by $75,900, of which $57,900 was related to the Inventory and Logistic Services segment and $18,000 was related to the Aircraft and Engine Sales and Leasing segment.

The fiscal 2002 writedown for the engine and airframe parts was determined by comparing the carrying value for inventory parts that support older generation aircraft to their net realizable value.  In determining net realizable value, we assigned estimated sales prices taking into consideration historical selling prices and demand, as well as anticipated demand.  The $11,400 writedown during fiscal 2002 for

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whole engines related to assets that are reported in the caption “Equipment on or available for short-term lease” and was determined by comparing the carrying value for each engine to an estimate of its undiscounted future cash flows.  In those instances where there was a shortfall, the impairment was measured by comparing the carrying value to an estimate of the asset’s fair market value.  The loss accruals for engine operating leases were determined by comparing the scheduled purchase option prices to the estimated fair value of such equipment.  In those instances where the scheduled purchase option price exceeded the estimated fair value, an accrual for the estimated loss was recorded (see Note K).

During the fourth quarter of fiscal 2003, we recorded additional impairment charges related to certain engine and airframe parts and whole engines in the amount of $5,360.  The fiscal 2003 impairment charge was based upon an updated assessment of the net realizable values for certain engine and airframe parts and future undiscounted cash flows for whole engines.  Of the $5,360 impairment charge recorded during fiscal 2003, $2,360 related to the Inventory and Logistic Services segment and $3,000 related to the Aircraft and Engine Sales and Leasing segment.

A summary of the carrying value of impaired inventory and engines, after giving effect to the impairment charges recorded by us are as follows:

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Proceeds from sales of impaired inventory and engines for the three-month periodsix-month periods ended August 31,November 30, 2004 and 2003 were $3,600 and $4,100, respectively.  Proceeds for the twelve-month period ended May 31, 2004 were $1,800 and $7,300, respectively.$7,300.

Note K – Aviation Equipment Operating Leases

From time to time we lease aviation equipment (engines and aircraft) from lessors under arrangements that are classified as operating leases.  We may also sublease the aviation equipment to a customer on a short- or long-term basis.  The terms of the operating leases in which we are the lessee are typically one year with options to renew annually at our election.  If we elect not to renew a lease or the lease term expires, we generally will purchase the equipment from the lessor at its scheduled purchase option price.  The terms of the lease agreements also allow us to purchase the equipment at any time during a lease at its scheduled purchase option price.   During the first quarter of fiscal 2005 ending August 31, 2004, we exercised our purchase option on three engines.  The acquisition price was $6,012 and the engines arewere reflected in inventoriesInventories on the August 31, 2004 Condensed Consolidated Balance Sheet.  The scheduled purchase option values of currently leased aviation equipment were $23,626$23,241 at August 31,November 30, 2004 and $30,097 at May 31, 2004.

In those instances in which we anticipate that we will purchase aviation equipment and the scheduled purchase option price will exceed the fair value of such equipment, we record an accrual for loss.  The accrual for loss was $5,800 at August 31,November 30, 2004 and May 31, 2004.

Note L – Segment Reporting

We are a leading provider of value-added products and services to the global aviation/aerospace industry. We report our activities in four business segments: Inventory and Logistic Services; Maintenance, Repair and Overhaul; Manufacturing; and Aircraft and Engine Sales and Leasing.

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Sales in the Inventory and Logistic Services segment are derived from the sale of a wide variety of new, overhauled and repaired engine and airframe parts and components to the commercial aviation and military markets, as well as the distribution of new airframe parts purchased from various original equipment manufacturers and sold to commercial and general aviation customers.  Cost of sales consists principally of the cost of product (primarily aircraft and engine parts) and overhead (primarily indirect labor, facility expenses and insurance).

Sales in the Maintenance, Repair and Overhaul segment are derived from the repair and overhaul of a wide range of commercial and military aircraft engine and airframe parts, landing gear and components, aircraft maintenance and storage, and the repair, overhaul and sale of parts for industrial gas and steam turbine operators.  Cost of sales consists principally of cost of product (primarily replacement aircraft parts), direct labor and overhead.

Sales in the Manufacturing segment are derived from the manufacture and sale of a wide array of containers, pallets and shelters used to support the U.S. Military’s tactical deployment requirements, in-plane cargo loading and handling systems for commercial and military applications and advanced composite materials and components for aerospace and industrial use.  Cost of sales consists principally of the cost of product, direct labor and overhead.

Sales in the Aircraft and Engine Sales and Leasing segment are derived from the sale and lease of commercial aircraft and engines and technical and advisory services.  Cost of sales consists principally of cost of product (aircraft and engines), labor and the cost of lease revenue (primarily depreciation, lease expense and insurance).

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The accounting policies for the segments are the same as those for the Company.  Our chief decision making officer evaluates performance based on the reportable segments.  The expenses and assets related to corporate activities are not allocated to the segments.

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AAR CORP. and Subsidiaries

Management’s Discussion and Analysis of Financial

Condition and Results of Operations
August 31,

November 30, 2004

(In thousands)

General Overview

We report our activities in four business segments: Inventory and Logistic Services; Maintenance, Repair and Overhaul; Manufacturing; and Aircraft and Engine Sales and Leasing.

Sales in the Inventory and Logistic Services segment are derived from the sale of a wide variety of new, overhauled and repaired engine and airframe parts and components to the commercial aviation and military markets, as well as the distribution of new airframe parts purchased from various original equipment manufacturers and sold to commercial and general aviation customers.  Cost of sales consists principally of the cost of product (primarily aircraft and engine parts) and overhead (primarily indirect labor, facility cost and insurance).

Sales in the Maintenance, Repair and Overhaul segment are derived from the repair and overhaul of a wide range of commercial and military aircraft engine and airframe parts, landing gear and components; aircraft maintenance and storage; and the repair, overhaul and sale of parts for industrial gas and steam turbine operators.  Cost of sales consists principally of cost of product (primarily replacement aircraft parts), direct labor and overhead.

Sales in the Manufacturing segment are derived from the manufacture and sale of a wide array of containers, pallets and shelters used to support the U.S. Military’s tactical deployment requirements, in-plane cargo loading and handling systems for commercial and military applications and advanced composite materials and components for aerospace and industrial use.  Cost of sales consists principally of the cost of product, direct labor and overhead.

Sales in the Aircraft and Engine Sales and Leasing segment are derived from the sale and lease of commercial aircraft and engines and technical and advisory services.  Cost of sales consists principally of cost of product (aircraft and engines), labor and the cost of lease revenue (primarily depreciation, lease expense and insurance).

The table below sets forth consolidated sales for our four business segments for the three-monththree- and six-month periods ended August 31,November 30, 2004 and 2003.

During fiscal 2004, positive signs such as year-over-year improvement in available seat miles, revenue passenger miles and load factors began to develop, suggesting the U.S. airline industry was improving. However, low yields, rising fuel prices and high labor costs and historically high fuel prices continue to threaten the economic viability of certain airlines. Recently, U.S. Airways filed for bankruptcy protection and Delta Airlines has warned that it may also file for bankruptcy protection.

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We continue to closely monitor our accounts receivable exposure to airline customers experiencing financial difficulty.

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Low cost carriers with little or no infrastructure to support their maintenance requirements have gained market share from the major U.S. carriers.  Certain of these low cost carriers are flying newer aircraft which willare expected to generate increasing demand for maintenance in future years.  We anticipate a fundamental shift in the way our airline customers manage their businesses, including intensified focus on cost control and increased use of third-party maintenance providers.  We believe we are well positioned with our broad range of products and services as these trends develop.

Results of Operations –

Three-Month Period Ended August 31,November 30, 2004

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

Consolidated sales for the firstsecond quarter of our fiscal year ending May 31, 2005 increased $13,939$19,136 or 9.2%12.0% over the same period in the prior year.  The increase in sales was primarily dueattributable to continued strong demand for our products supporting the U.S. Military’s tactical deployment requirements as a result of U.S. Military activitydefense efforts and increased demand in our traditionalsales of parts business supportingand services to commercial airlines.aviation customers.  Although it is very difficult to predict the duration of U.S. Military activity and its impact on our near-term results, we believe we are well positioned with our products and services to benefit from both near-term and longer-term U.S. Military deployment and program management strategies.

In the Inventory and Logistic Services segment, sales increased $855decreased $3,031 or 1.4%4.4% compared to the prior year period.  We experienced double-digitThe decrease was principally due to lower sales growthto the U.S. Military and its contractors for spares and logistics support compared to record sales from a year ago, as well as a decline in our traditionalsales to general aviation customers as we continue to exit low margin product lines in the new parts distribution unit.  Increased sales of engine and airframe parts supply business supportingto commercial airlines, whileairline customers partially offset the sales for our new parts distribution business declined as we continued to de-emphasize offerings of lower margin products, mostly to general aviation customers.reductions within the segment.

Sales in the Maintenance, Repair and Overhaul segment decreased $6,775increased $679 or 12.7%1.3% compared to the same period in the prior year primarily due to decreased demand for industrial gas turbineincreased sales of landing gear and component repair services, andpartially offset by lower levels of activitysales at our airframeaircraft maintenance facility as a result of the timing of airframe maintenance due to heavy summer aircraft utilization of a major customer.facility.

In the Manufacturing segment, sales increased $18,619$15,725 or 74.0%49.6% compared to the prior year period as we experienced continued strong demand for our manufactured products supporting U.S. Military tactical deployment activities.  Our composites manufacturing facility also experienced increased sales at all of our business units within this segment.  The increase in sales is principally due to strong sales toduring the U.S. Military for products supporting tactical deployment requirements as well asquarter reflecting increased sales of cargo systems and composite structures to airlinedemand from commercial aviation customers.

In the Aircraft and Engine Sales and Leasing segment, sales increased $1,240$5,763 or 10.5% asmore than double the level of sales in the prior year period.  The increase was a result of increasedthe sale of four aircraft sales induring the quarter.second quarter of fiscal 2005.

Consolidated gross profit increased $5,499$3,448 or 26.0%13.7% over the prior year period due to an increase in the gross profit margin to 16.0% compared to 13.9%15.8% in the prior year. The gross profit margin percentage increased primarily due a favorable product mix largely due to the mix of products soldgeneral aviation downsizing and operational improvements within the Inventory and Logistic Services segment and the impact of operating efficiencieshigher volumes within the Manufacturing segment.

Operating income improvedincreased by $4,700$2,325 from the prior year period as a result of increased sales and an improvement in the gross profit margin, partially offset by slightly higher selling, general and administrative expenses.  Our selling, general and administrative costs increased by $799$1,123 or 4.1% 5.8%

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compared to the same period in the prior year principally due to higher selling expenses resulting from increased personnel related costs.  As a percentage of sales, selling, general and administrative costs declined from 12.2% to 11.5%.  Net interest expense decreased $1,321$343 or 29.1%8.2% due to lower overall outstanding borrowings and lower weighted average interest rates.

17During the second quarter of fiscal 2005 ending November 30, 2004, we recorded a favorable federal income tax adjustment of $1,575 or $0.05 per share.  In October 2004, the American Jobs Creation Act of 2004 (the “Act”) was signed into law.  The Act included a number of federal income tax reforms, including an extension of the foreign tax credit carryforward period from five years to ten years.  In previous fiscal years, we had established a deferred tax valuation allowance of $1,575 against foreign tax credits expiring in fiscal year 2006.  As a result of the new ten-year carryforward period established by the Act, we now expect to utilize the foreign tax credits and recorded a $1,575 credit to the provision for income taxes during the second quarter of fiscal 2005.

As a result of the factors discussed above, our consolidated net income was $4,839 compared to $916 in the prior year.

Six-Month Period Ended November 30, 2004

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

Consolidated sales for the six-month period ending November 30, 2004 increased $33,075 or 10.6% over the same period in the prior year.  The increase in sales was primarily attributable to continued strong demand for our products supporting U.S. defense efforts and increased sales of parts and services to commercial aviation customers.  Although it is very difficult to predict the duration of U.S. Military activity and its impact on our near-term results, we believe we are well positioned with our products and services to benefit from both near-term and longer-term U.S. Military deployment and program management strategies.

Sales in the Inventory and Logistic Services segment decreased $2,176 or 1.7% compared to the prior year due to lower sales to general aviation customers as we continue to de-emphasize certain lower margin products and lower sales of logistics support to our defense customers compared with record sales in the prior year.  Sales of engine and airframe parts increased due to higher demand from commercial aviation customers.

In the Maintenance, Repair and Overhaul segment, sales decreased $6,096 or 5.7% as we experienced decreased demand for industrial gas turbine overhaul services and lower sales at our aircraft maintenance facility.  Increased demand for landing gear repairs and engine component repair services partially offset the reductions within the segment.

In the Manufacturing segment, sales increased $34,344 or 60.3% compared to the prior year period as we experienced increased sales at all of our business units within the segment.  We continue to experience strong sales to the U.S. Military for products supporting defense efforts and expect this trend to continue into future quarters.  We also experienced increased demand of cargo systems and composite structures to airline customers within the segment.

Sales in the Aircraft and Engine Sales and Leasing segment increased $7,003 or 40.6% as a result of several aircraft sales in the current year.

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Consolidated gross profit increased $8,947 or 19.3% compared with the prior year.  The increase in our gross profit is primarily attributable to the increase in sales and an increase in the gross profit margin to 16.0% from 14.8% in the prior year.  The gross profit percentage increased primarily due to the mix of products sold within the Inventory and Logistics Services segment largely due to general aviation downsizing and operational efficiencies obtained within the Manufacturing segment.

Operating income increased $7,025 compared with the prior year primarily due to the increase in gross profit, partially offset by higher selling, general and administrative costs.  During the six month period ended November 30, 2004, our selling, general and administrative costs increased $1,922 or 4.9% primarily due to added resources to support company-wide growth.  As a percentage of sales, selling, general and administrative costs declined from 12.6% to 11.9%.  Net interest expense decreased $1,664 or 19.0% due to lower overall outstanding borrowings, lower weighted average interest rates and a first quarter $995 gain recorded on the early retirement of debt, partially offset by $500 of additional interest expense associated with outstanding litigation.

During the second quarter of fiscal 2005 ending November 30, 2004, we recorded a favorable federal income tax adjustment of $1,575 or $0.05 per share.  In October 2004 American Jobs Creation Act of 2004 (the “Act”) was signed into law.  The Act included a number of federal income tax reforms, including an extension of the foreign tax credit carryforward period from five years to ten years.  In previous fiscal years, we had established a deferred tax valuation allowance of $1,575 against foreign tax credits expiring in fiscal year 2006.  As a result of the new ten-year carryforward period established by the Act, we now expect to utilize the foreign tax credits and recorded a $1,575 credit to the provision for income taxes during the second quarter of fiscal 2005.

As a result of the factors discussed above, our consolidated net income was $2,286$7,125 compared to a loss of  $1,996$1,080 in the prior year.

Factors Which May Affect Future Results

Our operating results and financial position may be adversely affected or fluctuate on a quarterly basis as a result of general economic conditions, geo-political events, the commercial airline environment and other factors, including:  (1) declining demand for our products and services and the ability of our customers to meet their financial obligations; (2) declining market values for aviation products and equipment; (3) difficulties in re-leasing or selling aircraft and engines that are currently being leased; (4) lack of assurance that sales to the U.S. Government, its agencies and its contractors (which were 34.1% of total sales in fiscal 2004 and 33.5% in the first quartersix months of fiscal 2005), will continue at levels previously experienced; (5) access to the debt and equity capital markets and the ability to draw down funds under financing agreements; (6) inability to comply with restrictive and financial covenants contained in certain of our loan agreements; (7) changes in or inability to comply with laws and regulations that may affect certain of our aviation related activities that are subject to licensing, certification and other regulatory requirements imposed by the FAA and other regulatory agencies, both domestic and foreign; (8) competition from other companies, including original equipment manufacturers, some of which have greater financial resources than us; (9) exposure to product liability and property claims that may be in excess of our substantial liability insurance coverage; and (10) the outcome of any pending or future material litigation or environmental proceedings.

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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 capital resources include secured credit arrangements, which include an accounts receivable securitization program and a secured revolving credit facility. 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 general economic conditions, airline and aviation industry conditions, geo-political events, including the war on terrorism, and our operating performance.  Our ability to use our accounts receivable securitization program and revolving credit facility is also dependent on these factors.  Our ability to generate cash from operations is influenced primarily by our operating performance and working capital management. We also have a universal shelf registration on file with the Securities and Exchange Commission under which, subject to market conditions, up to $163,675 of common stock, preferred stock or medium- or long-term debt securities may be issued or sold.

At August 31,November 30, 2004, our liquidity and capital resources included cash of $26,802$19,667 and working capital of $256,728.$265,780.  As of August 31,November 30, 2004, $8,553$9,248 of cash was restricted to support letters of credit.  At August 31,November 30, 2004, we had $35,000$50,000 available under our accounts receivable securitization program; no accounts receivable were securitized as of that date.  The amount available under this agreement is based on a formula of qualifying accounts receivable. At August 31,November 30, 2004, we had $24,620$26,207 available under our secured revolving credit facility; no amounts were outstanding as of that date.  The amount available under the revolving credit facility is also based on a formula of qualifying assets.  As of August 31,November 30, 2004,

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unrestricted cash and amounts available to us under our secured credit arrangement and accounts receivable securitization program totaled $77,869.$86,626.

We continue to evaluate other financing arrangements on commercially reasonable terms that would allow us to improve our liquidity position and finance future growth.  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 first quarter, we retired $6,890 of 6.875% notes payable due in December 2007 and $8,000 of 2.875% convertible notes due in February 2024.  The notes were repurchased for $13,638, and we charged $257 of related capitalized financing costs to operations.

In July 2005, non-recourse notes of $31,834$31,666 mature and therefore have been classified as current on the August 31,November 30, 2004 Condensed Consolidated Balance Sheet.  If we do not successfully negotiate an extension to the financing with the lender, we willexpect to return the aircraft that secures the notes to the lender and write-off our equity investment in the aircraft.  As of August 31,November 30, 2004, our equity investment in the aircraft was $1,720.$1,388.

During the three-monthsix-month period ended August 31,November 30, 2004, we generated $5,552$8,571 of cash from operations primarily due to a reduction in accounts receivable of $9,195 and $6,785$13,691 of non-cash depreciation and amortization and a decrease in equipment on or available for long-term lease of $3,630, partially offset by a decrease in accrued liabilities of $6,509 and an increase in inventories of $6,918 in other assets consisting primarily$5,604 and $5,324 of deposits and prepaids.pension contributions.

During the three-monthsix-month period ended August 31,November 30, 2004, our investing activities used $5,500$14,344 of cash principally reflecting capital expenditures of $3,604$6,700 and the acquisition of an investment inaircraft for $7,287 which will be contributed to a joint venture during the third quarter of $1,401.fiscal 2005.

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