10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended February 28, 2007

or

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

For the transition period from                 to                

Commission File No.  1-6263

AAR CORP.

(Exact name of registrant as specified in its charter)

Delaware	36-2334820
(State or other jurisdiction of incorporation	(I.R.S. Employer Identification No.)
or organization)

One AAR Place, 1100 N. Wood Dale Road
Wood Dale, Illinois	60191
(Address of principal executive offices)	(Zip Code)

(630) 227-2000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x      No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer x     Accelerated filer o     Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o     No x

As of March 31, 2007, there were 37,293,937 shares of the registrant’s Common Stock, $1.00 par value per share, outstanding.

AAR CORP. and Subsidiaries

Quarterly Report on Form 10-Q

For the Quarter Ended February 28, 2007

Table of Contents

			Page
Part I — FINANCIAL INFORMATION
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets	3-4
		Condensed Consolidated Statements of Operations	5
		Condensed Consolidated Statements of Cash Flows	6
		Condensed Consolidated Statements of Comprehensive Income	7
		Notes to Condensed Consolidated Financial Statements	8-18
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19-27
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
	Item 4.	Controls and Procedures	28
Part II — OTHER INFORMATION
	Item 1A.	Risk Factors	29
	Item 6.	Exhibits	29
	Signature Page		30
	Exhibit Index		31

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PART I — FINANCIAL INFORMATION

Item 1 — Financial Statements

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of February 28, 2007 and May 31, 2006

(In thousands)

	February 28,		May 31,
	2007		2006
	(Unaudited)
Assets:
Current assets:
Cash and cash equivalents	$	105,111	$	121,738
Accounts receivable, less allowances of $5,310 and $6,466, respectively	158,499		136,272
Inventories	246,052		259,570
Equipment on or available for short-term lease	92,628		64,022
Deposits, prepaids and other	18,704		12,986
Deferred tax assets	24,489		29,866
Total current assets	645,483		624,454
Property, plant and equipment, net of accumulated depreciation of $141,224 and $129,896, respectively	81,816		72,637
Other assets:
Goodwill	55,528		44,432
Equipment on long-term lease	126,288		140,743
Investment in joint ventures	23,583		28,498
Other	78,151		68,055
	283,550		281,728
	$	1,010,849	$	978,819

The accompanying Notes to Condensed Consolidated Financial
Statements are an integral part of these statements.

3

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of February 28, 2007 and May 31, 2006

(In thousands)

	February 28,			May 31,
	2007			2006
	(Unaudited)
Liabilities and stockholders’ equity:
Current liabilities:
Short-term debt	$	64		$	161
Current maturities of long-term debt	31,366			200
Current maturities of non-recourse long-term debt	22,794			1,928
Accounts payable	91,869			97,002
Accrued liabilities	86,916			88,497
Total current liabilities	233,009			187,788
Long-term debt, less current maturities	252,913			293,263
Non-recourse debt	—			25,313
Deferred tax liabilities	37,637			25,357
Other liabilities and deferred income	17,589			24,381
	308,139			368,314
Stockholders’ equity:
Preferred stock, $1.00 par value, authorized 250 shares; none issued	—			—
Common stock, $1.00 par value, authorized 100,000 shares; issued 41,729 and 40,789 shares, respectively	41,729			40,789
Capital surplus	282,932			274,211
Retained earnings	238,206			197,392
Treasury stock, 4,501 and 4,135 shares at cost, respectively	(79,813		)	(69,664		)
Unearned restricted stock awards	—			(6,169		)
Accumulated other comprehensive loss	(13,353		)	(13,842		)
	469,701			422,717
	$	1,010,849		$	978,819

The accompanying Notes to Condensed Consolidated Financial
Statements are an integral part of these statements.

4

AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Operations

For the Three and Nine Months Ended February 28, 2007 and 2006

(Unaudited)

(In thousands, except per share data)

	Three Months Ended						Nine Months Ended
	February 28,						February 28,
	2007			2006			2007			2006
Sales:
Sales from products	$	226,216		$	185,473		$	629,072		$	530,267
Sales from services	37,860			30,783			105,746			87,966
Sales from leasing	6,902			7,142			20,674			17,632
	270,978			223,398			755,492			635,865
Costs and operating expenses:
Cost of products	186,330			149,870			516,150			437,524
Cost of services	32,705			26,117			89,787			71,075
Cost of leasing	4,668			4,305			13,354			12,121
Cost of sales-impairment charges	—			—			7,652			—
Selling, general and administrative and other	24,770			25,340			76,509			72,007
	248,473			205,632			703,452			592,727
Gain on sale of product line	—			—			5,358			—
Earnings from aircraft joint ventures	2,983			262			9,785			1,060
Operating income	25,488			18,028			67,183			44,198
Gain (loss) on extinguishment of debt	—			(3,893		)	2,927			(3,893		)
Interest expense	(3,568		)	(4,806		)	(12,970		)	(13,434		)
Interest income	1,293			849			3,932			1,811
Income before provision for income taxes	23,213			10,178			61,072			28,682
Provision for income taxes	7,694			983			19,342			6,208
Income from continuing operations	15,519			9,195			41,730			22,474
Discontinued operations:
Operating loss, net of tax	(258		)	(65		)	(917		)	(210		)
Net income	$	15,261		$	9,130		$	40,813		$	22,264
Earnings per share-basic:
Earnings from continuing operations	$	0.43		$	0.27		$	1.15		$	0.69
Loss from discontinued operations	(0.01		)	—			(0.03		)	(0.01		)
Earnings per share - basic	$	0.42		$	0.27		$	1.12		$	0.68
Earnings per share-diluted:
Earnings from continuing operations	$	0.37		$	0.24		$	1.00		$	0.63
Loss from discontinued operations	(0.01		)	—			(0.02		)	(0.01		)
Earnings per share - diluted	$	0.36		$	0.24		$	0.98		$	0.62
Weighted average common shares outstanding - basic	36,534			33,709			36,285			32,723
Weighted average common shares outstanding - diluted	43,496			39,150			43,092			37,397

The accompanying Notes to Condensed Consolidated Financial
Statements are an integral part of these statements.

5

AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

For the Nine Months Ended February 28, 2007 and 2006

(Unaudited)

(In thousands, except per share data)

	Nine Months Ended
	February 28,
	2007			2006
Cash flows from operating activities:
Net income	$	40,813		$	22,264
Adjustments to reconcile net income to net cash provided from (used in) operating activities:
Depreciation and amortization	24,089			21,556
Deferred tax provision	17,657			6,578
Gain on sale of product line	(5,358		)	—
Impairment charges	7,652			—
Loss (gain) on extinguishment of debt	(2,927		)	3,893
Earnings from aircraft joint ventures	(9,785		)	—
Changes in certain assets and liabilities:
Accounts and trade notes receivable	(18,027		)	(26,980		)
Inventories	3,622			(37,618		)
Equipment on or available for short-term lease	(10,496		)	(1,851		)
Equipment on long-term lease	(16,336		)	(72,990		)
Accounts payable	(4,973		)	15,183
Accrued liabilities and taxes on income	(10,863		)	697
Other liabilities	(4,723		)	10,383
Other	(9,445		)	(3,190		)
Net cash provided from (used in) operating activities	900			(62,075		)
Cash flows from investing activities:
Property, plant and equipment expenditures	(20,524		)	(11,812		)
Proceeds from disposal of assets	51			24
Proceeds from sale of product line	6,567			—
Company acquired	(11,800		)	—
Investment in aircraft joint ventures	16,393			(16,214		)
Investment in leveraged leases	245			275
Other	(3,136		)	138
Net cash used in investing activities	(12,204		)	(27,589		)
Cash flows from financing activities:
Proceeds from borrowings	8,980			161,000
Reduction in borrowings	(19,782		)	(16,782		)
Financing costs	(864		)	(5,166		)
Other, primarily stock option exercises	6,562			5,124
Net cash provided from (used in) financing activities	(5,104		)	144,176
Effect of exchange rate changes on cash	(219		)	(37		)
Increase (decrease) in cash and cash equivalents	(16,627		)	54,475
Cash and cash equivalents, beginning of period	121,738			50,338
Cash and cash equivalents, end of period	$	105,111		$	104,813

The accompanying Notes to Condensed Consolidated Financial
Statements are an integral part of these statements.

6

AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

For the Three and Nine Months Ended February 28, 2007 and 2006

(Unaudited)

(In thousands)

	Three Months Ended					Nine Months Ended
	February 28,					February 28,
	2007			2006		2007			2006
Net income	$	15,261		$	9,130	$	40,813		$	22,264
Other comprehensive income (loss) -
Cumulative translation adjustments	(57		)	371		553			(1,148		)
Unrealized loss on investment	(64		)	—		(64		)	—
Total comprehensive income	$	15,140		$	9,501	$	41,302		$	21,116

The accompanying Notes to Condensed Consolidated Financial
Statements are an integral part of these statements.

7

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2007
(Unaudited)
(In thousands, except per share amounts)

Note 1 — Basis of Presentation

AAR CORP. and its subsidiaries are referred to herein collectively as “AAR,” “Company,” “we,” “us,” and “our” unless the context indicates otherwise.  The accompanying condensed consolidated financial statements include the accounts of AAR and its subsidiaries after elimination of intercompany accounts and transactions.

We have prepared these statements without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”).  The condensed consolidated balance sheet as of May 31, 2006 has been derived from audited financial statements.  To prepare the financial statements in conformity with U.S. generally accepted accounting principles, 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 U.S. generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations of the SEC.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our latest annual report on Form 10-K.

In the opinion of management, the condensed consolidated financial statements reflect all adjustments (which consist only of normal recurring adjustments) necessary to present fairly the condensed consolidated financial position of AAR CORP. and its subsidiaries as of February 28, 2007, and the condensed consolidated statements of operations, cash flows and comprehensive income for the three- and nine-month periods ended February 28, 2007 and 2006.  The results of operations for such interim periods are not necessarily indicative of the results for the full year.

Effective June 1, 2006, we adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment,” using the modified prospective method.  Under this method, compensation expense is recognized beginning in fiscal year 2007 for stock option grants made after May 31, 2006 and for the unvested portion of outstanding stock options that were granted prior to the adoption of SFAS No. 123(R).  We measure compensation cost based on the fair value of the award and recognize the expense on a straight-line basis over the vesting period.  In accordance with the modified prospective method of transition, the financial statements for prior periods have not been restated.  See Note 5 of Notes to Condensed Consolidated Financial Statements for further discussion of the adoption of SFAS 123(R) and the impact on the period ended February 28, 2007.

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Note 2 — Discontinued Operations

During the third quarter of fiscal 2007, we decided to exit our non-core industrial turbine business based in Frankfort, New York.  The industrial turbine business is a unit within the Structures and Systems segment and is expected to be sold within 12 months.  Net assets of the business were approximately $4,200 at February 28, 2007 and consisted of $1,350 of accounts receivable, $1,150 of inventory, $2,100 of net property, plant and equipment and $400 of accounts payable.

Revenues and pre-tax operating loss for the three- and nine-month periods ended February 28, 2007 and 2006 for the discontinued operation are summarized as follows:

	Three Months Ended						Nine Months Ended
	February 28,						February 28,
	2007			2006			2007			2006
Revenues	$	1,644		$	2,589		$	5,395		$	7,939
Pre-tax operating loss	(397		)	(101		)	(1,160		)	(323		)

Note 3 — Acquisitions

On January 12, 2007, we acquired substantially all the assets of Reebaire Aircraft, Inc. (“Reebaire”), a regional airframe maintenance and repair overhaul facility located in Hot Springs, Arkansas.  This acquisition increases our regional MRO capacity in North America.  The purchase price was approximately $11,800 and was paid in cash.  The results of operations since the date of acquisition are not material and are included in our Maintenance, Repair and Overhaul segment.

Our cost to acquire Reebaire has been preliminarily allocated to the assets acquired according to estimated fair values.  The allocation is subject to adjustment when additional information concerning asset valuations is finalized.  We have preliminarily allocated $11,075 to acquired goodwill, representing the excess of the purchase price over the estimated fair value of assets acquired.  We anticipate that the asset valuation will be completed in the first quarter of fiscal 2008.

Subsequent Event

On April 2, 2007, we acquired Brown International Corporation (“Brown”), a privately held defense contractor that provides engineering, design, manufacturing and systems integration services. Brown will operate as part of our Structures and Systems segment. The purchase price was approximately $23,750 and was paid in cash. The purchase price is subject to a working capital adjustment based on the balance sheet as of April 2, 2007.

Note 4 — Marketable Securities

As of February 28, 2007, we have invested $5,400 in equity securities which are classified as available for sale and included in deposits, prepaids and other in the Condensed Consolidated Balance Sheets.  During the third quarter of fiscal 2007, the unrealized loss on investment in equity securities was $64 and was recorded in Other Comprehensive Income.

Note 5 — Accounting for Stock-Based Compensation

We provide stock-based awards under the AAR CORP. Stock Benefit Plan (“Stock Benefit Plan”) which has been approved by our stockholders.  Under this plan, we are authorized to issue stock options to employees and non-employee directors that allow the grant recipients to purchase shares of common stock at a price not less than the fair market value of the common stock on the date of grant.  Generally, stock options awarded under the plan expire ten years from the date of grant and are exercisable in either four or five equal annual increments commencing one year after the date of grant.  We issue new common stock upon the exercise of stock options.  In addition to stock options, the Stock Benefit Plan also provides for the issuance of restricted stock awards and performance based restricted stock awards, as

9

well as for the granting of stock appreciation units; however, to date, no stock appreciation units have been granted.

Restricted stock grants are designed, among other things, to align employee interests with the interests of stockholders and to encourage the recipient to build a career with the Company.  Restricted stock typically vests over periods of three to ten years from date of grant.  Restricted stock grants may be performance-based with vesting to occur over periods of one to ten years after the grant is earned.  All restricted stock which has not vested carries full dividend and voting rights.

Typically, stock options and restricted stock are subject to forfeiture prior to vesting if the employee terminates employment for any reason other than death, retirement or disability or if we terminate employment for cause.  A total of 4,635 shares have been granted under the Stock Benefit Plan since its inception and as of February 28, 2007, awards representing 3,363 shares were available for future grant under the Stock Benefit Plan.

Effective June 1, 2006, we adopted SFAS No. 123(R), using the modified prospective method of transition.  Under SFAS No. 123(R) compensation expense is recognized for stock option grants made after May 31, 2006 and for the unvested portion of outstanding stock options that were granted prior to the adoption of SFAS No. 123(R).  Compensation cost is measured based on the fair value of the award and recognized on a straight line basis over the vesting period.

Prior to the adoption of SFAS No. 123(R), we accounted for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” and SFAS No. 123, “Accounting for Stock-Based Compensation”. Under APB 25, no compensation expense was recognized for stock option grants, and accordingly share-based compensation related to stock options granted prior to June 1, 2006 was included as pro forma disclosure in the consolidated financial statements.

On April 11, 2006, our Board of Directors approved the acceleration of the vesting of all unvested stock options.  As a result of this action, stock options representing approximately 679 shares that were scheduled to vest in fiscal 2007, 2008 and 2009 became fully exercisable effective May 1, 2006.  The accelerated vesting enabled us to reduce the amount of compensation expense that would otherwise be required to be recognized in our consolidated statements of operations with respect to these options upon the adoption of SFAS No. 123(R).  The aggregate expense that was eliminated as a result of the acceleration was approximately $1,800.  The acceleration resulted in a non-cash, one-time pre-tax stock compensation expense of $362 in the fourth quarter of fiscal 2006.

On June 1, 2006, we granted stock options representing 100 shares to a select group of key leadership track employees.  No executive officers were included in the group that received stock option grants.  No stock options were granted during the nine-month period ended February 28, 2006 other than reload options, which resulted from the exercise of original stock options granted in prior years.  Effective May 1, 2006, the reload provision was eliminated from substantially all outstanding stock option arrangements.

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The weighted average fair value of stock options granted during the nine-month periods ended February 28, 2007 and 2006 was $11.93 and $3.64, respectively.  The fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

	Nine Months Ended
	February 28,
	2007		2006
Risk-free interest rate	5.0	%	4.2	%
Expected volatility of common stock	58.7	%	37.8	%
Dividend yield	0.0	%	0.0	%
Expected option term in years	4.0		1.0

The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant.  The expected volatility is based on historical volatility of our common stock and the expected option term represents the period of time that the stock options granted are expected to be outstanding based on historical exercise trends.  The dividend yield represents our anticipated cash dividends over the expected option term.

The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to our stock option plan for the three- and nine-month periods ended February 28, 2006:

		Three Months			Nine Months
		Ended			Ended
		February 28, 2006			February 28, 2006
Net income as reported		$	9,130		$	22,264
Add: Stock-based compensation expense included in net income as reported, net of tax		677			1,517
Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of tax		(2,151		)	(4,842		)
Pro forma net income		$	7,656		$	18,939
Earnings per share — basic:	As reported	$	0.27		$	0.68
	Pro forma	$	0.23		$	0.58
Earnings per share — diluted:	As reported	$	0.24		$	0.62
	Pro forma	$	0.20		$	0.53

The adoption of SFAS No. 123(R) on June 1, 2006 reduced our income from continuing operations for the three- and nine-month periods ended February 28, 2007 by $60 and $180, respectively, and had no impact on basic and diluted earnings per share.

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The following table summarizes stock option activity for the nine-month period ended February 28, 2007:

					Weighted
			Weighted		Average	Aggregate
	Number of		Average		Remaining	Intrinsic
	Options		Exercise		Contractual	Value
	(in thousands)		Price		Life (years)	(in thousands)
Outstanding at May 31, 2006	3,080		$	16.88
Granted	100		$	24.08
Exercised	(908	)	$	17.41
Cancelled	(25	)	$	17.30
Outstanding at February 28, 2007	2,247		$	18.28	3.7	$	24,269
Exercisable at February 28, 2007	2,150		$	18.02	3.5	$	23,221

The total fair value of stock options that vested during the nine-month periods ended February 28, 2007 and 2006 was $0 and $1,628, respectively.  The total intrinsic value of stock options exercised during the three-month periods ended February 28, 2007 and 2006 was $2,953 and $2,084, respectively.  During the nine-month periods ended February 28, 2007 and 2006, the total intrinsic value of stock options exercised was $6,044 and $3,052, respectively.  The tax benefit realized from stock options exercised during the nine month periods ended February 28, 2007 and 2006 was $0.  As of February 28, 2007, we had $1,013 of unearned compensation related to stock options that will be amortized over an average period of five years.

The fair value of restricted shares is the market value of our common stock on the date of grant.  Amortization expense related to restricted shares during the three-month periods ended February 28, 2007 and 2006 was $1,012 and $1,041, respectively.  Amortization expense related to restricted shares during the nine-month periods ended February 28, 2007 and 2006 was $2,624 and $2,334, respectively.

Restricted share activity during the nine-month period ended February 28, 2007 is as follows:

			Weighted Average
	Number of		Fair Value
	Shares		on Grant Date
Nonvested at May 31, 2006	785		$	15.06
Granted	21		$	22.68
Vested	(195	)	$	14.20
Forfeited	(3	)	$	15.88
Nonvested at February 28, 2007	608		$	15.62

During the nine-month period ended February 28, 2007, we granted a total of 21 restricted shares to members of the Board of Directors and one non-executive employee. As of May 31, 2006, the unamortized balance of restricted shares was included in unearned restricted stock awards, a separate component of stockholders’ equity.  Upon the adoption of SFAS No. 123(R), the balance was reclassified to Capital Surplus.  As of February 28, 2007 we had $4,581 of unearned compensation related to restricted shares that will be amortized to expense over a weighted average period of 1.9 years.

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Note 6 — Revenue Recognition

Sales and related cost of sales for product sales are recognized upon shipment of the product to the customer.  Our standard terms and conditions provide that title passes to the customer when the product is shipped to the customer.  Sales of certain defense products are recognized upon customer acceptance, which includes transfer of title and transfer of risk of loss.  Sales from services and the related cost of services are generally recognized when customer-owned material is shipped back to the customer.  We have adopted this accounting policy because at the time the customer-owned material is shipped back to the customer, all services related to that material are complete as our service agreements generally do not require us to provide services at customer sites.  Furthermore, 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 used in a particular month.  Lease income associated with these contingent rentals is recorded in the period in which actual usage is reported to us by the lessee, which is normally the month following the actual usage.

Certain supply chain management programs we provide 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.

Note 7 — Inventory

The summary of inventories is as follows:

	February 28,	May 31,
	2007	2006
Raw materials and parts	$48,526	$58,421
Work-in-process	31,320	30,651
Purchased aircraft, parts, engines and components held for sale	166,206	170,498
	$246,052	$259,570

Note 8 — Supplemental Cash Flow Information

	Nine Months Ended
	February 28,
	2007		2006
Interest paid	$	13,083	$	13,231
Income taxes paid	1,816		556
Income tax refunds received	1,197		1,137

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Note 9 — Financing Arrangements

On August 31, 2006, we entered into a $140,000 unsecured revolving credit facility with LaSalle Bank National Association and various other lenders.  Under certain circumstances, we may request an increase to the revolving commitment in an aggregate amount of up to $35,000, not to exceed $175,000 in total.  The credit facility expires on August 31, 2010 and borrowings under the facility bear interest at LIBOR plus 125 to 200 basis points based on certain financial measurements.  The credit facility also includes a non-use fee which is currently equal to 30 basis points on the unused portion of the facility.  There were no borrowings outstanding under this facility at February 28, 2007.

In conjunction with entering into the new credit facility, we terminated our secured revolving credit agreement with Merrill Lynch Capital during the first quarter of fiscal 2007 and our accounts receivable securitization program during the second quarter of fiscal 2007.  No borrowings were outstanding and no accounts receivable were sold at the date of termination. No material penalties or fees resulted from the termination of these arrangements.

Note 10 — Earnings per Share

The computation of basic earnings per share is based on the weighted average number of common shares outstanding during each period.  The computation of diluted earnings per share is based on the weighted average number of common shares outstanding during the period plus, when their effect is dilutive, incremental shares consisting of shares subject to stock options, shares issuable upon vesting of restricted stock awards and shares to be issued upon conversion of convertible debt.

In the third quarter of fiscal 2005, we adopted the provisions of Emerging Issues Task Force Issue No. 04-08, “The Effect of Contingently Convertible Instruments on Diluted Earnings per Share” (“EITF No. 04-08”), which requires companies to account for contingently convertible debt using the “if converted” method set forth in SFAS No. 128, “Earnings Per Share,” for calculating diluted earnings per share.  Under the “if converted” method, the after-tax effect of interest expense related to the convertible securities is added back to net income, and the convertible debt is assumed to have been converted into common shares at the beginning of the period.

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The following table provides a reconciliation of the computations of basic and diluted earnings per share information for the three- and nine-month periods ended February 28, 2007 and 2006.

	Three Months Ended February 28,						Nine Months Ended February 28,
	2007			2006			2007			2006
Income from continuing operations	$	15,519		$	9,195		$	41,730		$	22,474
Loss from discontinued operations, net of tax	(258		)	(65		)	(917		)	(210		)
Net income	$	15,261		$	9,130		$	40,813		$	22,264
Basic shares:
Weighted average common shares outstanding	36,534			33,709			36,285			32,723
Earnings per share — basic:
Earnings from continuing operations	$	0.43		$	0.27		$	1.15		$	0.69
Loss from discontinued operations	(0.01		)	—			(0.03		)	(0.01		)
Earnings per share - basic	$	0.42		$	0.27		$	1.12		$	0.68
Net income	$	15,261		$	9,130		$	40,813		$	22,264
Add: After-tax interest on convertible debt	491			358			1,474			969
Net income for diluted EPS calculation	$	15,752		$	9,488		$	42,287		$	23,233
Diluted shares:
Weighted average common shares outstanding	36,534			33,709			36,285			32,723
Additional shares from the assumed exercise of stock options	536			696			405			468
Additional shares from the assumed vesting of restricted stock	449			458			425			374
Additional shares from the assumed conversion of convertible debt	5,977			4,287			5,977			3,832
Weighted average common shares outstanding — diluted	43,496			39,150			43,092			37,397
Earnings per share — diluted:
Earnings from continuing operations	$	0.37		$	0.24		$	1.00		$	0.63
Loss from discontinued operations	(0.01		)	—			(0.02		)	(0.01		)
Earnings per share - diluted	$	0.36		$	0.24		$	0.98		$	0.62

At February 28, 2007 and 2006, respectively, stock options to purchase 87 and 1,300 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 during the interim periods then ended.

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Note 11 —Aircraft Joint Ventures

We have invested in limited liability companies that are accounted for under the equity method of accounting.  Our membership interest in these limited liability companies is 50% and the primary business of these companies is the acquisition, ownership, lease and disposition of certain narrow-body commercial aircraft.  Acquired aircraft are purchased with cash contributions by the members of the companies and debt financing provided on a limited recourse basis.  The total number of aircraft held in joint ventures is 15.  Under the terms of a servicing agreement with certain of the limited liability companies, we provide administrative services and technical advisory services, including aircraft evaluations, oversight and logistical support of the maintenance process, records management and lease and bank negotiations.  We also provide remarketing services with respect to the divestiture of aircraft by the limited liability companies.  For the nine-month periods ended February 28, 2007 and 2006, we were paid $816 and $393, respectively, for such services.  The income tax benefit or expense related to the operations of the ventures is recorded by the member companies.

Summarized financial information for these limited liability companies is as follows:

	Three Months Ended February 28,				Nine Months Ended February 28,
	2007		2006		2007		2006
Statement of operations information:
Sales	$	6,625	$	3,146	$	44,993	$	23,572
Income before provision for income taxes	1,935		633		10,146		2,503

	February 28,		May 31,
	2007		2006
Balance sheet information:
Assets	$	145,479	$	123,177
Debt	96,115		64,934
Members’ capital	43,363		54,949

We also have an investment in an aircraft joint venture company that we consolidate.  We consolidate the financial position and results of operations of this joint venture because we are the primary beneficiary of the joint venture.  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 February 28, 2007.

Note 12 — Gain on Sale of Product Line

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.  In conjunction with the asset purchase and sale agreement, we entered into a transition services agreement with the buyer whereby we will continue to support the product line, and provide other administrative and operational services as defined, until such time as the purchaser has commenced manufacturing at its facility.  Proceeds from the sale 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 SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.

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Note 13 — Impairment Charges

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 prior years.  The fiscal 2007 impairment charge was triggered by our decision to aggressively pursue the liquidation of this inventory.  We made this decision to recognize 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.

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

	February 28,		May 31,		November 30,
	2007		2006		2001
Net impaired inventory and engines	$	27,900	$	36,000	$	89,600

Proceeds from sales of impaired inventory and engines for the nine-month period ended February 28, 2007 and the twelve-month period ended May 31, 2006 were $2,600 and $7,300, respectively.

Other Impairment and Gain on Extinguishment of Debt

During the first quarter of fiscal 2007, we restructured the lease and non-recourse debt on a wholly-owned wide-body aircraft.  This aircraft was originally purchased prior to September 11, 2001.  As a result of the restructuring of the lease and debt, we recorded a $2,927 gain on extinguishment of debt.  Further, we decided to offer this aircraft for sale and recorded a $2,902 impairment charge to reduce the carrying value of the aircraft to its estimated net realizable value.  The asset and related debt have been reclassified to current from long term.

Note 14 — Business Segment Information

We are a diversified provider of products and services to the worldwide aviation and aerospace and defense industries. We report our activities in four business segments: Aviation Supply Chain; Maintenance, Repair and Overhaul; Structures and Systems; and Aircraft Sales and Leasing.

Sales in the Aviation Supply Chain segment are derived from the sale and lease of a wide variety of new, overhauled and repaired engine and airframe parts and components to the commercial aviation and defense markets, as well as the repair and overhaul of a wide range of commercial and military aircraft airframe parts.  We also provide customized inventory supply and management and performance-based logistics programs for engine and airframe parts and components.  Sales also include the sale and lease of commercial jet engines.  Cost of sales consists principally of the cost of product (primarily aircraft and engine parts), direct labor and overhead (primarily indirect labor, facility cost and insurance).

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Sales in the Maintenance, Repair and Overhaul segment are principally derived from aircraft maintenance and storage and the repair and overhaul of most commercial landing gear types.  Cost of sales consists principally of the cost of product (primarily replacement aircraft parts), direct labor and overhead.

Sales in the Structures and Systems segment are derived from the manufacture and sale 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 composite products for aerospace and industrial use.  Cost of sales consists principally of the cost of product, direct labor and overhead.

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

The accounting policies for the segments are the same as those described in Note 1 of the notes to the consolidated financial statements included in our annual report on Form 10-K for the year ended May 31, 2006.  Our chief operating decision making officer (Chief Executive Officer) evaluates performance based on the reportable segments and utilizes gross profit as a primary profitability measure.  The expenses and assets related to corporate activities are not allocated to the segments.  Our reportable segments are aligned principally around differences in products and services.

Gross profit is calculated by subtracting cost of sales from sales.  Selected financial information for each reportable segment is as follows:

	Three Months Ended February 28,				Nine Months Ended February 28,
	2007		2006		2007		2006
Sales:
Aviation Supply Chain	$	135,687	$	117,170	$	397,107	$	332,274
Maintenance, Repair and Overhaul	52,265		43,591		146,337		124,820
Structures and Systems	62,992		59,276		183,872		169,102
Aircraft Sales and Leasing	20,034		3,361		28,176		9,669
	$	270,978	$	223,398	$	755,492	$	635,865

	Three Months Ended February 28,				Nine Months Ended February 28,
	2007		2006		2007		2006
Gross profit:
Aviation Supply Chain	$	29,862	$	27,776	$	82,013	$	70,062
Maintenance, Repair and Overhaul	7,260		6,008		20,564		16,713
Structures and Systems	8,921		8,251		25,162		25,783
Aircraft Sales and Leasing	1,232		1,071		810		2,587
	$	47,275	$	43,106	$	128,549	$	115,145

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Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations

AAR CORP. and Subsidiaries
February 28, 2007
(In thousands)

General Overview

We report our activities in four business segments: Aviation Supply Chain; Maintenance, Repair and Overhaul; Structures and Systems; and Aircraft Sales and Leasing.

Sales in the Aviation Supply Chain segment are derived from the sale and lease of a wide variety of new, overhauled and repaired engine and airframe parts and components to the commercial aviation and defense markets, as well as the repair and overhaul of a wide range of commercial and military aircraft airframe parts.  We also provide customized inventory supply and management and performance-based logistics programs for engine and airframe parts and components.  Sales also include the sale and lease of commercial jet engines.  Cost of sales consists principally of the cost of product (primarily aircraft and engine parts), direct labor and overhead (primarily indirect labor, facility cost and insurance).

Sales in the Maintenance, Repair and Overhaul segment are principally derived from aircraft maintenance and storage and the repair and overhaul of most commercial landing gear types.  Cost of sales consists principally of the cost of product (primarily replacement aircraft parts), direct labor and overhead.

Sales in the Structures and Systems segment are derived from the manufacture and sale 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 composite products for aerospace and industrial use.  Cost of sales consists principally of the cost of product, direct labor and overhead.

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

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The table below sets forth consolidated sales for our four business segments for the three- and nine-month periods ended February 28, 2007 and 2006.

	Three Months Ended February 28,				Nine Months Ended February 28,
	2007		2006		2007		2006
Sales:
Aviation Supply Chain	$	135,687	$	117,170	$	397,107	$	332,274
Maintenance, Repair and Overhaul	52,265		43,591		146,337		124,820
Structures and Systems	62,992		59,276		183,872		169,102
Aircraft Sales and Leasing	20,034		3,361		28,176		9,669
	$	270,978	$	223,398	$	755,492	$	635,865

During calendar year 2006, many of the domestic commercial airlines reported improved financial results reflecting their ability to implement fare increases to partially offset the relative continued high cost of fuel.  The improvement has also been driven by the airlines’ continued focus on controlling non-fuel related expenses, the implementation of operational efficiencies and relatively high load factors.  We expect certain 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-cost carriers 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.  We believe we remain well positioned to respond to the market with our broad range of products and services as these trends continue to develop.

We continue to experience growing demand for performance-based logistic services and strong shipments of specialized mobility products supporting our defense customers’ deployment activities.  Although it remains difficult for us to predict long-term demand for these types of products and services, we believe we remain well positioned with our current products and services and growth plans to benefit from longer-term U.S. military deployment and program management strategies.  We continue to monitor 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.

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Results of Operations

Three-Month Period Ended February 28, 2007
(as compared with the same period of the prior year)

Consolidated sales for the third quarter ended February 28, 2007 increased $47,580 or 21.3% over the third quarter of last year as all four of our reportable segments experienced an increase in sales. Sales in the Aviation Supply Chain segment increased $18,517 or 15.8% over the prior year. This sales increase reflects strong demand for engine and airframe parts and component repairs from commercial customers due to improved sourcing and program execution, the implementation of new supply chain programs and the improved commercial airline environment. Gross profit in the Aviation Supply Chain segment increased $2,086 or 7.5% over the prior year quarter primarily due to increased sales volume. The gross profit margin percentage decreased to 22.0% from 23.7% in the prior year quarter due to the unfavorable mix of products sold and lower margins in our component repair business.

In the Maintenance, Repair and Overhaul segment, sales increased $8,674 or 19.9% from the same quarter last year. The increase in sales is primarily attributable to increased demand for airframe maintenance at our Oklahoma City facility, increased demand for landing gear overhaul services and the inclusion of approximately $1,400 of revenue from Reebaire (see Note 3 of Notes to Condensed Consolidated Financial Statements) which was acquired in January 2007. Gross profit in the Maintenance, Repair and Overhaul segment increased $1,252 or 20.8% and the gross profit percentage increased from 13.8% to 13.9% as our landing gear and Oklahoma City airframe maintenance businesses improved their gross profit during the quarter reflecting increased sales for these services and operational efficiencies.

In the Structures and Systems segment, sales increased $3,716 or 6.3% over the prior year. Sales increased at our Mobility Systems business attributable to the development and delivery of increasingly complex and specialized shelter products and higher volume of pallets. Sales of cargo systems declined compared to the prior year as we continued to relocate production to a new manufacturing facility in Goldsboro, North Carolina. Gross profit in the Structures and Systems segment increased $670 or 8.1% compared to the prior year and the gross profit margin percentage increased from 13.9% to 14.2% due to the favorable mix of products sold.

In the Aircraft Sales and Leasing segment, sales increased $16,673 compared with the prior year quarter driven by a $16,500 sale of two owned aircraft at book value. During the third quarter, we also sold our interest in two aircraft through a joint venture. The increase in earnings from aircraft joint ventures compared to the prior year is primarily due to the sale of our interest in the two aircraft. At February 28, 2007, the total number of aircraft held in joint venture was 15 (see Note 11 of Notes to Condensed Consolidated Financial Statements). Our strategy is to build an aircraft portfolio through participation in joint ventures and for our own account. We also wholly-own six aircraft outside of the joint ventures. Of the six aircraft owned by us outside the aircraft joint ventures, five were acquired prior to September 11, 2001. Current lease rates for many commercial aircraft are less than pre-September 11 levels.

Operating income increased $7,460 or 41.4% compared with the prior year’s quarter due to increased sales and earnings from aircraft joint ventures. Selling, general and administrative expenses as a percentage of sales decreased to 9.1% compared to 11.3% in the prior year as we continue to leverage our cost structure and benefited from a $700 bad debt recovery. Net interest expense decreased $1,682 or 42.5% due to lower average borrowings, an increase in interest income on higher average invested cash during the period and the favorable impact of capitalized interest of approximately $590. Our effective

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income tax rate increased to 33.1% compared to 9.7% in the prior year due to lower anticipated tax benefits on export activities.

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 this business were $1,644 for the three-month period ended February 28, 2007.

Income from continuing operations was $15,519 for the third quarter of fiscal 2007 compared to $9,195 in the prior year due to the factors discussed above.

Nine-Month Period Ended February 28, 2007
(as compared with the same period of the prior year)

Consolidated sales for the nine-months ended February 28, 2007 increased $119,627 or 18.8% over the same period last year. Each reporting segment experienced sales growth with sales to commercial customers increasing 23.8% and sales to defense customers up 10.8% compared to the prior year. The sales increase to commercial airline customers reflects the improved commercial airline environment, our expanded presence in global markets, growth in supply chain programs, and increased demand for airframe maintenance and landing gear overhaul services. Sales to defense customers increased as we continue to experience strong demand for performance-based logistics programs and specialized mobility products.

Sales in the Aviation Supply Chain segment increased $64,833 or 19.5% over the prior year. The sales increase reflects strong demand for engine and airframe parts from commercial customers due 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 performance-based logistics programs. Gross profit in the Aviation Supply Chain segment increased $11,951 or 17.1% over the prior year primarily due to increased sales volume, partially offset by an impairment charge of $4,750 recorded in this segment during the first quarter of fiscal 2007 (see Note 13 of Notes to Condensed Consolidated Financial Statements). The gross profit margin percentage decreased slightly to 20.7% from 21.1% in the prior year due to the unfavorable mix of products sold and the impairment charge.

In the Maintenance, Repair and Overhaul segment, sales increased $21,517 or 17.2% 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 $3,851 or 23.0% over the prior year and the gross profit margin percentage increased to 14.1% from 13.4% as our landing gear and Oklahoma City businesses improved their gross profit, reflecting robust demand for these services and operational efficiencies.

In the Structures and Systems segment, sales increased $14,770 or 8.7% 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 of our cargo systems were lower as we began relocating production to a new manufacturing facility in North Carolina. Gross profit in the Structures and Systems segment declined $621 or 2.4% compared to the prior year as the gross profit margin percentage decreased from 15.2% to 13.7% due to the unfavorable mix of products sold.

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In the Aircraft Sales and Leasing segment, sales increased $18,507 compared with the prior year principally due to the $16,500 sale of two aircraft at book value. During the first nine months of fiscal 2007, our joint ventures purchased six aircraft and sold seven. The increase in earnings from aircraft joint ventures compared to the prior year is primarily due to the sale of these seven aircraft. At February 28, 2007, the total number of aircraft held in joint venture was 15 (see Note 11 of Notes to Condensed 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 six aircraft outside of the joint ventures. Of the six aircraft owned by us outside the aircraft joint ventures, five were acquired prior to September 11, 2001. Current lease rates for aircraft are less than pre-September 11 levels. Gross profit in the Aircraft Sales and Leasing segment decreased $1,777 compared to the prior year principally due to the impairment charge of $2,902 recorded during the first quarter of fiscal 2007 (see Note 13 of Notes to Condensed Consolidated Financial Statements).

During the first quarter of fiscal 2007, we recorded impairment charges of $7,652 related to certain inventory acquired prior to September 11, 2001, as well as an aircraft that we decided to offer for sale. An impairment charge of $4,750 was recorded for engine parts that were acquired prior to September 11, 2001, and were subject to impairment charges recorded in prior years. The fiscal 2007 impairment charge was triggered by our decision to aggressively pursue the liquidation of this inventory. We made this decision to recognize 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 Condensed Consolidated Financial Statements). In the Aircraft Sales and Leasing segment, we recorded an impairment charge of $2,902 on a wide-body aircraft originally purchased 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 $22,985 or 52.0% compared with the prior year’s period due to increased sales, earnings from aircraft joint ventures and gain on sale of product line partially offset by impairment charges and an increase in selling, general and administrative expenses. During the first nine months of fiscal 2007, our selling, general and administrative expenses increased $4,502 or 6.3% over the prior year primarily due to increased resources to support our growth. Selling, general and administrative expenses as a percentage of sales decreased to 10.1% compared to 11.3% in the prior year. Net interest expense decreased $2,585 or 22.2% primarily due to an increase in interest income on higher average invested cash during the period and capitalized interest of $649. Our effective income tax rate for the nine-months ended February 28, 2007 was 31.7% compared to 21.6% in the prior year due to lower anticipated tax benefits on export activities. We expect our effective income tax rate to be 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

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discontinued operation. Sales for this business were $5,395 for the nine-month period ended February 28, 2007.

Income from continuing operations was $41,730 compared to $22,474 in the prior year due to the factors discussed above.

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. 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 generate cash from operations is influenced primarily by our operating performance and changes in working capital. We 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 February 28, 2007, our liquidity and capital resources included cash of $105,111 and working capital of $412,474. On August 31, 2006, we entered into a credit agreement with various financial institutions, as lenders, and LaSalle Bank National Association, as administrative agent for the lenders (the “LaSalle Credit Agreement”). The LaSalle Credit Agreement created a $140,000 unsecured revolving credit facility that we can draw upon for general corporate purposes. Under certain circumstances, we may request an increase to the revolving commitment by an aggregate amount of up to $35,000, not to exceed $175,000 in total. The LaSalle Credit Agreement expires on August 31, 2010. Borrowings under the LaSalle Credit Agreement bear interest at the London Interbank Offered Rate (“LIBOR”) plus 125 to 200 basis points based on certain financial measurements. There were no borrowings outstanding under this facility at February 28, 2007. On August 31, 2006, we terminated our secured revolving credit agreement with Merrill Lynch Capital and during the second quarter 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. In addition, no material penalties or fees resulted from the terminations. In addition to our domestic facility, we also have $2,896 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 nine-month period ended February 28, 2007, we generated $900 of cash from operations primarily due to net income and depreciation and amortization of $64,902, partially offset by investments made in equipment on both short-and long-term lease of $26,832, an $18,027 increase in accounts receivable reflecting higher sales, and a reduction in accrued liabilities of $15,586 principally reflecting a payment for equipment acquired during fiscal 2006 to support a supply chain program.

During the nine-month period ended February 28, 2007, our investing activities used $12,204 of cash, principally as a result of capital expenditures of $20,524 and an acquisition of $11,800 (see Note 3 of Notes to Condensed Consolidated Financial Statements), partially offset by cash generated from

24

aircraft for joint ventures of $16,393 and proceeds from the sale of a product line of $6,567 (see Note 12 of Notes to Condense Consolidated Financial Statements).

During the nine-month period ended February 28, 2007, cash used in financing activities was $5,104, comprised principally of a reduction in borrowings of $19,782, which includes $9,034 for the early retirement of 6.875% Notes due December 15, 2007, partially offset by proceeds from borrowings of $8,980 and cash proceeds from stock option exercises of $6,562.

Contractual Obligations and Off-Balance Sheet Arrangements

A summary of contractual obligations and off-balance sheet arrangements as of February 28, 2007 is as follows:

	Payments Due by Period
	Total		2/28/08		2/28/09		2/28/10		2/28/11		2/28/12		After 2/28/12
On Balance Sheet:
Debt	$	284,279	$	31,366	$	20,200	$	200	$	158	$	55,000	$	177,355
Non-recourse debt	22,794		22,794		—		—		—		—		—
Bank borrowings	64		64		—		—		—		—		—
Interest	89,265		11,387		9,807		8,681		8,471		6,902		44,017
Off Balance Sheet:
Garden City operating lease	29,451		1,446		1,483		1,520		1,558		1,596		21,848

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 adjustments to reduce the value of inventories and equipment on or available for lease, allowance for doubtful accounts, revenue recognition 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.

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’s current and expected future financial performance.

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

25

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 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 additional impairment charges in future periods.

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 estimates concerning the overall profitability of the program and the relative fair value of each element of the arrangement. Differences may occur between the judgments and estimates made by management and actual program results.

Equipment on or Available for Lease

The cost of assets under lease is original purchase price plus overhaul costs. Depreciation is computed using the straight-line method over the estimated service life of the equipment, and maintenance costs are expensed as incurred.

In accordance with Statement of Financial Accounting Standards No. 144 (“SFAS No. 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets”, we are required to test for impairment of long-lived assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable from its undiscounted cash flows. When applying the provisions of SFAS No. 144 to equipment on or available for lease, we have utilized certain assumptions to estimate future undiscounted cash flows, including current and future lease rates, lease terms, residual values and market conditions and trends impacting future demand. Differences between actual results and the assumptions utilized by us when determining undiscounted cash flows could result in future impairments of aircraft and engines which are currently being leased or are available for lease.

Pension Plans

The liabilities and net periodic cost of our pension plans are determined utilizing several actuarial assumptions, the most significant of which are the discount rate and the expected long-term return on plan assets.

Our discount rate is determined based on a review of long-term, high quality corporate bonds as of May 31, 2006 and models that match projected benefit payments to coupons and maturities from the high quality bonds. The assumption for the expected long-term return on plan assets is developed through analysis of historical asset returns by investment category, our fund’s actual return experience and current market conditions. Changes in the discount rate and differences between expected and actual return on

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plan assets will impact the amount of net periodic pension expense recognized in our Consolidated Statement of Operations.

New Accounting Standards

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (SFAS No. 158). SFAS No. 158 requires employers to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position, recognize changes in that funded status in the year in which the changes occur through comprehensive income and measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year. The recognition provisions of SFAS No. 158 are effective for fiscal years ending after December 15, 2006 and the measurement provisions are effective for fiscal years ending after December 15, 2008. We anticipate that the impact of adopting the recognition provisions of SFAS No. 158 will increase our pension liability by approximately $6,100 and will reduce shareholders’ equity by approximately $4,000.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 provides guidance regarding the process by which misstatements in financial statements are evaluated for purposes of determining whether financial statement restatement is necessary. SAB 108 is effective for fiscal years ending after November 15, 2006, and early application is encouraged. We do not believe SAB 108 will have a material impact on our results from operations or financial position.

In July 2006, the FASB issued Interpretation No. 48 (FIN No. 48), “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.” FIN No. 48 clarifies the recognition threshold and measurement requirements for tax positions taken or expected to be taken in tax returns and provides guidance on the related classification and disclosure. The provisions of FIN No. 48 are effective for fiscal years beginning after December 15, 2006. Accordingly, we will adopt FIN No. 48 no later than the beginning of fiscal year 2008. We do not believe FIN No. 48 will have a material impact on our results from operations or financial position.

Forward-Looking Statements

This report contains certain forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on beliefs of Company management, as well as assumptions and estimates based on information available to the Company as of the dates such assumptions and estimates are made, and are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated, depending on a variety of factors, including those factors discussed under Part II, Item 1A under the heading “Risk Factors”. Should one or more of those risks or uncertainties materialize adversely, or should underlying assumptions or estimates prove incorrect, actual results may vary materially from those described. Those events and uncertainties are difficult or impossible to predict accurately and many are beyond the Company’s control. The Company assumes no obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

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Item 3 — Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes to our market risk as set forth in our Annual Report on Form 10-K for the year ended May 31, 2006.

Item 4 — Controls and Procedures

As required by Rules 13a-15(e) and 15d-15(e) of the Exchange Act, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of February 28, 2007. This evaluation was carried out under the supervision and with participation of our Chief Executive Officer and Chief Financial Officer. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures. Therefore, effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based upon our evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of February 28, 2007, ensuring that information required to be disclosed in the reports that are filed under the Exchange Act is recorded, processed, summarized and reported in a timely manner.

There were no changes in our internal control over financial reporting during the third quarter ended February 28, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 1A — Risk Factors

There have been no material changes to our risk factors as set forth in our Annual Report on Form 10-K for the year ended May 31, 2006.

Item 6 — Exhibits

The exhibits to this report are listed on the Exhibit Index included elsewhere herein.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		AAR CORP.
		(Registrant)
Date:	April 4, 2007	/s/ TIMOTHY J. ROMENESKO
		Timothy J. Romenesko Vice President and Chief Financial Officer (Principal Financial Officer and officer duly authorized to sign on behalf of registrant)
		/s/ MICHAEL J. SHARP
		Michael J. Sharp Vice President — Controller (Principal Accounting Officer)

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EXHIBIT INDEX

Exhibit No.	Description		Exhibits
31.	Rule 13a-14(a)/15(d)-14(a) Certifications	31.1	Section 302 Certification dated April 4, 2007 of David P. Storch, Chairman, President and Chief Executive Officer of Registrant (filed herewith).
		31.2	Section 302 Certification dated April 4, 2007 of Timothy J. Romenesko, Vice President and Chief Financial Officer of Registrant (filed herewith).
32.	Section 1350 Certifications	32.1	Section 906 Certification dated April 4, 2007 of David P. Storch, Chairman, President and Chief Executive Officer of Registrant (filed herewith).
		32.2	Section 906 Certification dated April 4, 2007 of Timothy J. Romenesko, Vice President and Chief Financial Officer of Registrant (filed herewith).

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EX-31.1

Exhibit 31.1

SECTION 302
CERTIFICATION

I, David P. Storch, Chairman, President and Chief Executive Officer of AAR CORP. (the “Registrant”), certify that:

1.I have reviewed this quarterly report on Form 10-Q of AAR CORP. for the quarterly period ending February 28, 2007;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;

4.The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have:

a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5.The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of the Registrant’s board of directors (or persons performing the equivalent functions):

a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and

b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

DATE: April 4, 2007

/s/ DAVID P. STORCH

David P. Storch

Chairman, President and Chief Executive Officer

EX-31.2

Exhibit 31.2

SECTION 302
CERTIFICATION

I, Timothy J. Romenesko, Vice President and Chief Financial Officer of AAR CORP. (the “Registrant”), certify that:

1.I have reviewed this quarterly report on Form 10-Q of AAR CORP. for the quarterly period ending February 28, 2007;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;

4.The Registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have:

a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)Disclosed in this report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s most recent fiscal quarter (the Registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5.The Registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditors and the audit committee of the Registrant’s board of directors (or persons performing the equivalent functions):

a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and

b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

DATE: April 4, 2007

/s/ TIMOTHY J. ROMENESKO

Timothy J. Romenesko

Vice President and Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the AAR CORP. (the “Company”) quarterly report on Form 10-Q for the period ending February 28, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, David P. Storch, Chief Executive Officer of the Company, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:

1.             The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

2.             The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: April 4, 2007

/s/ DAVID P. STORCH

David P. Storch

Chairman, President and Chief Executive Officer

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the AAR CORP. (the “Company”) quarterly report on Form 10-Q for the period ending February 28, 2007 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Timothy J. Romenesko, Chief Financial Officer of the Company, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to the best of my knowledge:

1.             The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

2.             The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: April 4, 2007

/s/ TIMOTHY J. ROMENESKO

Timothy J. Romenesko

Vice President and Chief Financial Officer