UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended November 30, 2008

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

For the transition period from to

Commission File No. 1-6263

AAR CORP.

(Exact name of registrant as specified in its charter)

Delaware

36-2334820

(State or other jurisdiction of incorporation

or organization)

(I.R.S. Employer Identification No.)

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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

Smaller reporting company 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 November 30, 2008, there were 38,670,275 shares of the registrant’s Common Stock, $1.00 par value per share, outstanding.

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PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of November 30, 2008 and May 31, 2008

(In thousands)

	November 30,		May 31,
	2008		2008
	(Unaudited)
Assets:
Current assets:
Cash and cash equivalents	$	121,764	$	109,391
Accounts receivable, less allowances of $5,108 and $5,977, respectively	203,182		202,472
Inventories	326,557		296,610
Equipment on or available for short-term lease	148,934		138,998
Deposits, prepaids and other	17,384		17,657
Deferred tax assets	19,987		18,303
Total current assets	837,808		783,431

Property, plant and equipment, net of accumulated depreciation of $165,826 and $166,070, respectively	149,753		146,435

Other assets:
Goodwill and other intangible assets, net	127,096		129,719
Equipment on long-term lease	124,727		163,958
Investment in joint ventures	43,496		42,734
Other	99,133		95,733
	394,452		432,144
	$	1,382,013	$	1,362,010

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

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AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of November 30, 2008 and May 31, 2008

(In thousands)

	November 30,			May 31,
	2008			2008
	(Unaudited)
Liabilities and stockholders’ equity:
Current liabilities:
Short-term debt	$	75,749		$	1,036
Current maturities of long-term debt	200			200
Current maturities of non-recourse long-term debt	11,941			20,212
Current maturities of long-term capital lease obligations	1,575			1,546
Accounts payable	108,076			99,073
Accrued liabilities	68,730			96,432
Total current liabilities	266,271			218,499

Long-term debt, less current maturities	409,648			478,308
Non-recourse debt	18,131			19,190
Capital lease obligations	9,674			10,420
Deferred tax liabilities	37,258			28,011
Other liabilities and deferred income	20,237			22,327
	494,948			558,256

Stockholders’ equity:
Preferred stock, $1.00 par value, authorized 250 shares; none issued	—			—
Common stock, $1.00 par value, authorized 100,000 shares; issued 43,955 and 43,932 shares, respectively	43,955			43,932
Capital surplus	326,208			324,074
Retained earnings	369,330			331,196
Treasury stock, 5,218 and 5,159 shares at cost, respectively	(101,745		)	(100,935		)
Accumulated other comprehensive loss	(16,954		)	(13,012		)
	620,794			585,255
	$	1,382,013		$	1,362,010

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 November 30, 2008 and 2007

(Unaudited)

(In thousands, except per share data)

	Three Months Ended November 30,						Six Months Ended November 30,
	2008			2007			2008			2007
Sales:
Sales from products	$	287,241		$	253,307		$	582,559		$	503,519
Sales from services	58,744			47,263			115,566			93,333
Sales from leasing	7,587			10,077			15,351			19,755
	353,572			310,647			713,476			616,607
Costs and operating expenses:
Cost of products	231,251			204,127			471,495			409,015
Cost of services	49,180			38,702			97,746			77,307
Cost of leasing	3,299			7,468			7,255			13,395
Cost of sales-impairment charge	21,033			—			21,033			—
Selling, general and administrative and other	38,205			30,941			75,003			61,603
	342,968			281,238			672,532			561,320
Earnings from joint ventures	4,364			1,965			5,812			2,985
Operating income	14,968			31,374			46,756			58,272
Gain on extinguishment of debt	22,098			—			23,208			—
Interest expense	(4,981		)	(5,026		)	(9,654		)	(9,364		)
Interest income and other	496			1,003			862			1,586
Income from continuing operations before provision for income taxes	32,581			27,351			61,172			50,494
Provision for income taxes	11,229			9,463			21,089			17,351
Income from continuing operations	21,352			17,888			40,083			33,143
Discontinued operations, net of tax:
Operating loss	(215		)	(33		)	(546		)	(135		)
Loss on disposal	(1,403		)	—			(1,403		)	—
Loss from discontinued operations	(1,618		)	(33		)	(1,949		)	(135		)
Net income	$	19,734		$	17,855		$	38,134		$	33,008
Earnings per share – basic:
Earnings from continuing operations	$	0.56		$	0.49		$	1.05		$	0.90
Loss from discontinued operations	(0.04		)	—			(0.05		)	—
Earnings per share – basic	$	0.52		$	0.49		$	1.00		$	0.90
Earnings per share – diluted:
Earnings from continuing operations	$	0.51		$	0.42		$	0.95		$	0.78
Loss from discontinued operations	(0.04		)	—			(0.04		)	—
Earnings per share – diluted	$	0.47		$	0.42		$	0.91		$	0.78
Weighted average common shares outstanding – basic	38,079			36,841			38,088			36,858
Weighted average common shares outstanding – diluted	42,802			43,732			42,877			43,770

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 Six Months Ended November 30, 2008 and 2007

(Unaudited)

(In thousands)

	Six Months Ended
	November 30,
	2008			2007
Cash flows from operating activities:
Net income	$	38,134		$	33,008
Adjustments to reconcile net income to net cash provided from (used in) operating activities:
Depreciation and amortization	21,486			19,391
Deferred tax provision – continuing operations	6,517			1,452
Tax benefits from exercise of stock options	(58		)	(2,184		)
Impairment charge	21,033			—
Gain on extinguishment of debt	(23,208		)	—
Earnings from joint ventures	(5,812		)	(2,985		)
Loss on disposal of business, net of tax	1,403			—
Gain on sale of investment	—			(605		)
Changes in certain assets and liabilities:
Accounts and trade notes receivable	(2,636		)	9,694
Inventories	(28,663		)	(30,097		)
Equipment on or available for short-term lease	182			(52,173		)
Equipment on long-term lease	257			(4,364		)
Accounts payable	10,020			(11,883		)
Accrued liabilities and taxes on income	(25,781		)	7,285
Other liabilities	(1,739		)	(6,817		)
Other, deposits and program costs	(3,008		)	(8,872		)
Net cash provided from (used in) operating activities	8,127			(49,150		)
Cash flows from investing activities:
Property, plant and equipment expenditures	(16,697		)	(14,112		)
Proceeds from disposal of assets	16			—
Proceeds from sale of business	100			—
Proceeds from aircraft joint ventures	3,900			877
Investment in aircraft joint ventures	(96		)	(23,289		)
Proceeds from sale of available for sale securities	—			11,536
Investment in available for sale securities	—			(10,931		)
Investment in leveraged leases	(26		)	627
Other	(884		)	(1,204		)
Net cash used in investing activities	(13,687		)	(36,496		)
Cash flows from financing activities:
Proceeds from borrowings	75,564			22,686
Reduction in borrowings	(55,378		)	(2,719		)
Proceeds from capital lease obligations	—			12,880
Reduction in capital lease obligations	(717		)	(340		)
Financing costs	(10		)	(500		)
Purchase of treasury stock	—			(8,147		)
Stock option exercises	152			4,438
Tax benefits from exercise of stock options	58			2,184
Net cash provided from financing activities	19,669			30,482
Effect of exchange rate changes on cash	(1,736		)	216
Increase (decrease) in cash and cash equivalents	12,373			(54,948		)
Cash and cash equivalents, beginning of period	109,391			83,317
Cash and cash equivalents, end of period	$	121,764		$	28,369

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 November 30, 2008 and 2007

(Unaudited)

(In thousands)

	Three Months Ended November 30,					Six Months Ended November 30,
	2008			2007		2008			2007
Net income	$	19,734		$	17,855	$	38,134		$	33,008

Other comprehensive income (loss) -
Cumulative translation adjustments	(1,676		)	2,148		(2,990		)	3,169
Unrealized loss on investment, net of tax	(664		)	—		(952		)	—
Total comprehensive income	$	17,394		$	20,003	$	34,192		$	36,177

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

November 30, 2008

(Unaudited)

(Dollars 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, 2008 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 November 30, 2008, the condensed consolidated results of operations, and comprehensive income for the three- and six-month periods ended November 30, 2008 and 2007, and the condensed consolidated cash flows for the six months ended November 30, 2008 and 2007. The results of operations for such interim periods are not necessarily indicative of the results for the full year.

Note 2 – 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 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 well as for the granting of stock appreciation units; however, to date, no stock appreciation units have been granted.

During the six-month periods ended November 30, 2008 and 2007, we granted stock options representing 184,750 shares and 88,000 shares, respectively, to a group of key leadership track employees.

Effective June 1, 2006, we adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment.”

The weighted average fair value of stock options granted during the six-month periods ended November 30, 2008 and 2007 was $8.27 and $13.46, respectively. The fair value of each stock option

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

November 30, 2008

(Unaudited)

(Dollars in thousands, except per share amounts)

grant was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

	Six Months Ended November 30,
	2008		2007
Risk-free interest rate	3.3	%	4.9	%
Expected volatility of common stock	38.9	%	43.1	%
Dividend yield	0.0	%	0.0	%
Expected option term in years	6.0		4.0

The following table summarizes stock option activity for the six-month period ended November 30, 2008:

	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value
	(in thousands)					(in thousands)
Outstanding at May 31, 2008	1,425		$	21.53
Granted	185		$	19.26
Exercised	(20	)	$	7.86
Cancelled	(85	)	$	19.85
Outstanding at November 30, 2008	1,505		$	21.37	5.4	$	2,410
Exercisable at November 30, 2008	1,212		$	20.44	4.5	$	2,410

The total fair value of stock options that vested during the six-month periods ended November 30, 2008 and 2007 was $434 and $231, respectively. The total intrinsic value of stock options exercised during the six-month periods ended November 30, 2008 and 2007 was $166 and $5,619, respectively. The tax benefit realized from stock options exercised during the six-month periods ended November 30, 2008 and 2007 was $58 and $2,184. Expense charged to operations for stock options during the three-month periods ended November 30, 2008 and 2007 was $196 and $119, respectively. Expense charged to operations for stock options during the six-month periods ended November 30, 2008 and 2007 was $389 and $227, respectively. As of November 30, 2008, we had $2,811 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 November 30, 2008 and 2007 was $1,340 and $1,576, respectively. Amortization expense related to restricted shares during the six-month periods ended November 30, 2008 and 2007 was $2,649 and $2,924, respectively.

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

November 30, 2008

(Unaudited)

(Dollars in thousands, except per share amounts)

Restricted share activity during the six-month period ended November 30, 2008 is as follows:

	Number of Shares		Weighted Average Fair Value on Grant Date
	(in thousands)
Nonvested at May 31, 2008	940		$	24.44
Granted	23		$	14.03
Vested	(270	)	$	16.01
Forfeited	(20	)	$	28.77
Nonvested at November 30, 2008	673		$	27.43

During the six-month period ended November 30, 2008, we granted a total of 22,500 restricted shares to members of the Board of Directors. As of November 30, 2008 we had $9,081 of unearned compensation related to restricted shares that will be amortized to expense over a weighted average period of 2.5 years.

Note 3 – Revenue Recognition

Sales and related cost of sales for product sales are recognized upon shipment of the product to the customer. Our standard terms and conditions provide that title passes to the customer when the product is shipped to the customer. Sales of certain defense products are recognized upon customer acceptance, which includes transfer of title. Sales from services and the related cost of services are generally recognized when customer-owned material is shipped back to the customer. We have adopted this accounting policy because at the time the customer-owned material is shipped back to the customer, all services related to that material are complete as our service agreements generally do not require us to provide services at customer sites. Furthermore, serviced units are typically shipped to the customer immediately upon completion of the related services. Sales and related cost of sales for certain long-term manufacturing contracts, certain large airframe maintenance contracts and certain long-term aircraft component maintenance agreements are recognized by the percentage of completion method, either based on the relationship of costs incurred to date to estimated total costs or the units of delivery method. 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.

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

November 30, 2008

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 4 – Inventory

The summary of inventories is as follows:

	November 30, 2008		May 31, 2008
Raw materials and parts	$	64,146	$	55,183
Work-in-process	51,154		47,576
Purchased aircraft, parts, engines and components held for sale	211,257		193,851
	$	326,557	$	296,610

Note 5 – Supplemental Cash Flow Information

	Six Months Ended November 30,
	2008		2007
Interest paid	$	8,803	$	8,456
Income taxes paid	25,565		6,677
Income tax refunds received	417		344

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

November 30, 2008

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 6 – Financing Arrangements

A summary of our recourse and non-recourse long-term debt is as follows:

	November 30, 2008			May 31, 2008
Recourse debt

Notes payable due May 15, 2011 with interest at 8.39% payable semi-annually on June 1 and December 1	$	42,000		$	42,000
Mortgage loan (secured by Wood Dale, Illinois facility) due August 1, 2015 with interest at 5.01%	11,000			11,000
Convertible notes payable due March 1, 2014 with interest at 1.625% payable semi-annually on March 1 and September 1	121,694			137,500
Convertible notes payable due March 1, 2016 with interest at 2.25% payable semi-annually on March 1 and September 1	85,025			112,500
Convertible notes payable due February 1, 2026 with interest at 1.75% payable semi-annually on February 1 and August 1	124,721			150,000
Industrial revenue bonds (secured by trust indenture on property, plant and equipment) due December 1, 2010 and August 1, 2018 with floating interest rate, payable monthly	25,408			25,508
Total recourse debt	409,848			478,508
Current maturities of recourse debt	(200		)	(200		)
Long-term recourse debt	$	409,648		$	478,308

Non-recourse debt

Non-recourse note payable due October 31, 2008 with interest at 5.66%	$	—		$	7,881
Non-recourse note payable due March 31, 2009 with interest at 6.18%	9,578			10,048
Non-recourse note payable due July 19, 2012 with interest at 7.22%	15,060			15,725
Non-recourse note payable due April 3, 2015 with interest at 8.38%	5,434			5,748
Total non-recourse debt	30,072			39,402
Current maturities of non-recourse debt	(11,941		)	(20,212		)
Long-term non-recourse debt	$	18,131		$	19,190

During February 2008, we completed the sale of $250,000 of convertible notes, consisting of $137,500 aggregate principal amount of 1.625% convertible senior notes due 2014 and $112,500 aggregate principal amount of 2.25% convertible senior notes due 2016 (together, the “Notes”) in a private offering to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. Interest under the Notes is payable semiannually on March 1 and September 1, beginning September 1, 2008.

Holders may convert their Notes based on a conversion rate of 28.1116 shares of our common stock per $1,000 principal amount of Notes, which is equivalent to an initial conversion price of $35.57 per share, only under the following circumstances: (i) during any calendar quarter beginning after March

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

November 30, 2008

(Unaudited)

(Dollars in thousands, except per share amounts)

31, 2008 (and only during such calendar quarter) if, as of the last day of the preceding calendar quarter, the closing price of our common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of such preceding calendar quarter is more than 130% of the applicable conversion price per share of common stock on the last day of such preceding calendar quarter; (ii) during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of notes of the applicable series for each day of that period was less than 98% of the product of the closing price of our common stock and the then applicable conversion rate; (iii) if a designated event or similar change of control transaction occurs; (iv) upon specified corporate transactions; or (v) beginning on February 1, 2014, in the case of the 2014 notes, or February 1, 2016, in the case of the 2016 notes, and ending at the close of business on the business day immediately preceding the applicable maturity date.

Upon conversion, a holder of the Notes will receive for each $1,000 principal amount, in lieu of common stock, an amount in cash equal to the lesser of (i) $1,000 and (ii) the conversion value of a number of shares of our common stock equal to the conversion rate. If the conversion value exceeds the principal amount, we will also deliver at our election, cash or common stock or a combination thereof having a value equal to such excess amount.

The Notes are senior, unsecured obligations and rank equal in right of payment with all of our existing and future unsecured and unsubordinated expenses. Costs associated with this transaction of approximately $6,028 are being amortized using the effective interest method over a six- and eight-year period.

In connection with the issuance of the Notes, we entered into convertible note hedge transactions, (“Note Hedges”) with respect to our common stock with Merrill Lynch Financial Markets, Inc. (“Hedge Provider”). The Note Hedges are exercisable solely in connection with any conversion of the Notes and provide for us to receive shares of our common stock from the Hedge Provider equal to the number of shares issuable to the holders of the Notes upon conversion. We paid $69,676 for the Note Hedges.

In addition, we entered into separate warrant transactions with Merrill Lynch Financial Markets, Inc. whereby we issued warrants to purchase 7,028,000 shares of our common stock at an exercise price of $48.83 per share. We received $40,114 from the sale of these warrants. The Note Hedges and warrant transactions are intended to reduce potential dilution to our common stock upon future conversion of the Notes and generally have the effect of increasing the conversion price of the Notes to approximately $48.83 per share.

Net proceeds from the Notes transaction after paying expenses were approximately $214,410 and were used to repay the balance outstanding under our unsecured revolving credit facility, to pay for the net cost of the Note Hedges and warrant transactions and for general corporate purposes.

During the second quarter of fiscal 2009, we retired $13,279 of our 1.75% convertible notes due February 1, 2026, $15,806 of our 1.625% convertible notes due March 1, 2014 and $27,475 of our 2.25% convertible notes due March 1, 2016. Collectively, the convertible notes were retired for $33,263 cash, and the gain after consideration of unamortized debt issuance costs of $22,098 is recorded in gain on extinguishment of debt on the condensed consolidated statement of operations for the three month period ended November 30, 2008.

During the first quarter of fiscal 2009, we retired $12,000 of our 1.75% convertible notes due February 1, 2026 for $10,633. The net gain from this transaction was $1,110, including pro-rata write-off

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

November 30, 2008

(Unaudited)

(Dollars in thousands, except per share amounts)

The following table provides a reconciliation of the computations of basic and diluted earnings per share information for the three- and six-month periods ended November 30, 2008 and 2007.

	Three Months Ended						Six Months Ended
	November 30,						November 30,
	2008			2007			2008			2007
Income from continuing operations	$	21,352		$	17,888		$	40,083		$	33,143
Loss from discontinued operations, net of tax	(1,618		)	(33		)	(1,949		)	(135		)
Net income	$	19,734		$	17,855		$	38,134		$	33,008

Basic shares:
Weighted average common shares outstanding	38,079			36,841			38,088			36,858

Earnings per share – basic:
Earnings from continuing operations	$	0.56		$	0.49		$	1.05		$	0.90
Loss from discontinued operations	(0.04		)	—			(0.05		)	—
Earnings per share - basic	$	0.52		$	0.49		$	1.00		$	0.90

Net income	$	19,734		$	17,855		$	38,134		$	33,008
Add: After-tax interest on convertible debt	377			491			761			983
Net income for diluted EPS calculation	$	20,111		$	18,346		$	38,895		$	33,991

Diluted shares:
Weighted average common shares outstanding	38,079			36,841			38,088			36,858
Additional shares from the assumed exercise of stock options	67			466			72			478
Additional shares from the assumed vesting of restricted stock	43			448			66			457
Additional shares from the assumed conversion of convertible debt	4,613			5,977			4,651			5,977
Weighted average common shares outstanding – diluted	42,802			43,732			42,877			43,770

Earnings per share – diluted:
Earnings from continuing operations	$	0.51		$	0.42		$	0.95		$	0.78
Loss from discontinued operations	(0.04		)	—			(0.04		)	—
Earnings per share - diluted	$	0.47		$	0.42		$	0.91		$	0.78

At November 30, 2008 and 2007, respectively, stock options to purchase 1,190,000 and 82,000 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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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

November 30, 2008

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 8 –Aircraft Portfolio

Joint Venture Aircraft

The Company owns aircraft with joint venture partners as well as aircraft which are wholly-owned. As of November 30, 2008, the Company had ownership interests in 27 aircraft with joint venture partners. During the second quarter of fiscal 2009, two aircraft from the Company’s joint venture portfolio were sold. The gain on the sale of the two aircraft contributed to the increase in earnings from joint ventures on the condensed consolidated statements of operations for the three- and six-month periods ended November 30, 2008 as compared to the prior year. All of the aircraft owned with joint venture partners were acquired in fiscal years 2006, 2007 and 2008. As of November 30, 2008, our equity investment in the 27 aircraft owned with joint venture partners is approximately $40,800 and is included in investment in joint ventures on the condensed consolidated balance sheet.

Our aircraft joint ventures represent investments in limited liability companies that are accounted for under the equity method of accounting. Our membership interest in each of these limited liability companies is 50% and the primary business of these companies is the acquisition, ownership, lease and disposition of certain commercial aircraft. Aircraft are purchased with cash contributions by the members of the companies and debt financing provided to the limited liability companies on a limited recourse basis. Twenty-seven aircraft were held in the joint ventures at November 30, 2008. Under the terms of servicing agreements 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 and records management. We also provide remarketing services with respect to the divestiture of aircraft by the limited liability companies. For the six-month periods ended November 30, 2008 and 2007 we were paid $0 and $232, respectively, for such services. The income tax benefit or expense related to the operations of the ventures is recorded by the member companies.

Distributions from joint ventures are classified as operating or investing activities in the consolidated statements of cash flows based upon an evaluation of the specific facts and circumstances of each distribution.

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

	Three Months Ended				Six Months Ended
	November 30,				November 30,
	2008		2007		2008		2007
Statement of operations information:
Sales	$	30,455	$	16,276	$	43,667	$	26,136
Income before provision for income taxes	8,968		4,467		12,254		6,798

	November 30,			May 31,
	2008			2008
Balance sheet information:
Assets	$	293,903		$	320,093
Debt	208,294			233,662
Members’ capital	81,600		*	80,299

* AAR’s equity interest is $40,800.

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

November 30, 2008

(Unaudited)

(Dollars in thousands, except per share amounts)

Wholly-Owned Aircraft

In addition to the aircraft owned with joint venture partners, we own seven aircraft for our own account which are considered wholly-owned. Of the seven aircraft, one aircraft is a leveraged lease, two aircraft were financed with non-recourse debt, one aircraft was financed with a non-recourse capital lease and the other three have no debt (See Note 11 – Impairment Charges). Our investment in the seven wholly-owned aircraft is comprised of the following components:

	November 30,			May 31,
	2008			2008
Gross carrying value	$	71,113		$	98,588
Non-recourse debt	(20,494		)	(29,354		)
Non-recourse capital lease obligation	(11,149		)	(11,837		)
Net AAR investment	$	39,470		$	57,397

Note 9 – Discontinued Operations

On November 25, 2008 we sold certain assets and liabilities of our industrial gas turbine engine business to the local management team. We retained ownership of the land and building and entered into a five-year lease with the buyer. As of November 30, 2008, the net book value of the land and building was $1,263. The industrial gas turbine engine business was a unit in the Structures and Systems segment. As consideration, we received cash of $100 and a $650 interest bearing note due in five equal annual installments beginning December 1, 2009. The note is secured by accounts receivable, inventory and equipment. We also have an opportunity to receive additional consideration based on the business achieving certain sales levels for a four-year period beginning January 1, 2009. As a result of this transaction, we recorded a pre-tax charge of $2,209 ($1,403 after tax) in the second quarter ended November 30, 2008, representing the loss on disposal. The loss on disposal represents the difference between the non-contingent consideration received and the net book value of the assets sold.

Revenues and pre-tax operating loss for the three- and six-month periods ended November 30, 2008 and 2007 for discontinued operations are summarized as follows:

	Three Months Ended						Six Months Ended
	November 30,						November 30,
	2008			2007			2008			2007

Revenues	$	466		$	1,660		$	852		$	3,185
Pre-tax operating loss	(333		)	(50		)	(841		)	(207		)
Pre-tax loss on disposal	(2,209		)	—			(2,209		)	—

Note 10 – Acquisitions

On December 3, 2007, we acquired Summa Technology, Inc. (“Summa”), a leading provider of high-end sub-systems and precision machining, fabrication, welding and engineering services located in Huntsville, Alabama. Summa operates as part of our Structures and Systems segment. The purchase price was approximately $71,000 and was paid in cash.

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

November 30, 2008

(Unaudited)

(Dollars in thousands, except per share amounts)

On March 5, 2008, we acquired Avborne Heavy Maintenance, Inc. (“Avborne”) and a related entity located in Miami, Florida. Avborne is an independent provider of aircraft heavy maintenance checks, modifications, installations and painting services to commercial airlines, international cargo carriers and major aircraft leasing companies. The purchase price was approximately $40,000 and included a cash payment of $15,000 and the assumption of a $25,000 industrial revenue bond. Avborne operates as part of our Maintenance, Repair and Overhaul segment.

We have made a preliminary purchase price allocation for the Avborne acquisition and are in the process of obtaining final valuations for the acquired net assets.

The following unaudited pro forma information is provided for acquisitions assuming the Summa and Avborne acquisitions occurred as of the beginning of fiscal year 2008:

	Three Months Ended		Six Months Ended
	November 30, 2007		November 30, 2007

Net sales	$	354,316	$	697,594
Operating income	34,969		64,119
Net income	19,308		34,992
Earnings per share:
Basic	$	0.52	$	0.95
Diluted	$	0.45	$	0.82

Note 11 – Impairment Charges

Aircraft – Acquired Pre-September 11, 2001

During the second quarter of fiscal 2009, we performed a comprehensive review of our aircraft portfolio. The primary objective of this review was to assess the impact of the economic slowdown and credit crisis on market conditions. Based upon that review, and taking into consideration the desire to improve liquidity and generate cash, we made the decision to sell one of the four owned aircraft acquired before September 11, 2001, and offer two of the remaining three for sale. As a result of this review and taking into consideration our assessment of current market conditions, the Company recorded a $21,033 pre-tax impairment charge to reduce the carrying value of the three aircraft to their net realizable value. As of November 30, 2008, the carrying value of the two aircraft subject to the impairment charge and offered for sale was approximately $11,800.

Parts and Engines – Acquired Pre-September 11, 2001

The events of September 11, 2001 caused a severe and sudden disruption in the commercial airline industry, which brought about the rapid acceleration of the retirement of older generation aircraft. Based on our assessment of these and other conditions, we reduced the value of certain inventory and engines that were acquired prior to September 11, 2001 during the three-month period ended November 30, 2001. The net carrying value of the parts and engines after taking into consideration the Fiscal 2002 impairment charge was $89,600 as of November 30, 2001. Since November 2001, we have been steadily reducing this pool of parts and engines. As of November 30, 2008, the carrying value of the impaired parts and engines was approximately $19,500. Proceeds from sales of impaired parts and engines for the six-month periods ended November 30, 2008 and 2007 were $1,300 and $1,600, respectively.

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AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

November 30, 2008

(Unaudited)

(Dollars in thousands, except per share amounts)

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

	Three Months Ended				Six Months Ended
	November 30,				November 30,
	2008		2007		2008		2007
Sales:
Aviation Supply Chain	$	146,082	$	144,784	$	299,596	$	287,492
Maintenance, Repair and Overhaul	87,437		68,679		173,747		131,326
Structures and Systems	114,712		79,783		231,481		156,281
Aircraft Sales and Leasing	5,341		17,401		8,652		41,508
	$	353,572	$	310,647	$	713,476	$	616,607

	Three Months Ended					Six Months Ended
	November 30,					November 30,
	2008			2007		2008			2007
Gross profit (loss):
Aviation Supply Chain	$	35,965		$	34,970	$	71,362		$	66,934
Maintenance, Repair and Overhaul	13,503			9,921		26,256			17,961
Structures and Systems	18,856			10,784		36,310			19,905
Aircraft Sales and Leasing	(19,515		)	4,675		(17,981		)	12,090
	$	48,809		$	60,350	$	115,947		$	116,890

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November 30, 2008

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

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. The table below sets forth consolidated sales for our four business segments for the three- and six-month periods ended November 30, 2008 and 2007.

	Three Months Ended				Six Months Ended
	November 30,				November 30,
	2008		2007		2008		2007
Sales:
Aviation Supply Chain	$	146,082	$	144,784	$	299,596	$	287,492
Maintenance, Repair and Overhaul	87,437		68,679		173,747		131,326
Structures and Systems	114,712		79,783		231,481		156,281
Aircraft Sales and Leasing	5,341		17,401		8,652		41,508
	$	353,572	$	310,647	$	713,476	$	616,607

In early 2008, many U.S. air carriers announced a series of cost reduction initiatives, including staffing reductions, route consolidations and capacity reductions. The fleet reductions announced in early 2008 were principally in response to high oil prices. More recent capacity reductions have been in response to the deteriorating economic environment. In addition, certain air carriers in the U.S. and abroad have filed for bankruptcy protection, and some have ceased operations. A reduction in the global operating fleet of passenger aircraft will result in reduced demand for parts support and maintenance activities for the types of aircraft affected.

Recent severe disruptions in the financial markets, together with continued tightening in the credit markets, may affect our customers’ ability to raise debt or equity capital. This may reduce the amount of liquidity available to our customers which, in turn, may limit their ability to buy parts, services and aircraft. There is also uncertainty over the direction of the U.S. and global economies as a result of slower growth rates, higher unemployment and weak housing markets. We are monitoring economic conditions for their impact on our customers and markets and assessing both risks and opportunities that may affect our business.

We expect many carriers will continue to seek ways to reduce their cost structure, including outsourcing more of their maintenance and support functions to third parties, while we believe other carriers who have historically outsourced their maintenance requirements will continue to do so. Although 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, the factors above may have an adverse impact on our growth rates and our results of operations and financial condition.

During the second quarter of fiscal 2009, sales to defense customers increased 32% and represented 43% of consolidated sales. We continue to see opportunities to provide performance-based logistics services and manufactured products supporting our defense customers’ requirements. Although it remains difficult for us to predict long-term demand for these types of products and services, we believe we are well positioned with our current portfolio of products and services and growth plans to benefit from longer-term U.S. military deployment and program management strategies.

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November 30, 2008

Results of Operations

Three-Month Period Ended November 30, 2008

Consolidated sales for the second quarter ended November 30, 2008 increased $42,925 or 13.8% over the prior year period due to acquisitions. Consolidated organic sales declined less than 1.0%. Sales to commercial customers increased 3.1% compared to the prior year reflecting increased sales to commercial customers in our Maintenance, Repair and Overhaul and Aviation Supply Chain segments. Sales to defense customers increased 32.2% reflecting increased sales to defense customers in the Structures and Systems and Aviation Supply Chain segments.

In the Aviation Supply Chain segment, sales increased $1,298 or 0.9% over the prior year’s period reflecting increased demand for parts support from defense-related performance-based logistics programs and aftermarket parts sales to commercial customers, offset by lower sales at our component repair business, reduced sales to a regional airline customer and the unfavorable impact of foreign currency translation. Gross profit in the Aviation Supply Chain segment increased $995 or 2.8% over the prior year due to the slight increase in sales and a slight increase in the gross profit margin percentage, which increased to 24.6% from 24.2% in the prior year.

In the Maintenance, Repair and Overhaul segment, sales increased $18,758 or 27.3% over the prior year. The increase in sales is attributable to the inclusion of revenue from Avborne, which was acquired in March 2008 and contributed approximately $17,000 of revenue during the second quarter of fiscal 2009, as well as increased revenue at our landing gear overhaul business. Gross profit in the Maintenance, Repair and Overhaul segment increased $3,582 or 36.1%, and the gross profit margin percentage increased to 15.4% from 14.4% in the prior year due to increased volume and operational improvement initiatives.

In the Structures and Systems segment, sales increased $34,929 or 43.8% over the prior year. The increase in sales is attributable to the inclusion of revenue from Summa, which was acquired in December 2007 and contributed approximately $28,000 of revenue during the second quarter of fiscal 2009, as well as continued strong demand for specialized mobility products. Gross profit in the Structures and Systems segment increased $8,072 or 74.9%, and the gross profit percentage increased to 16.4% from 13.5%, in the prior year due to increased shipments of higher margin products and improvements at our cargo systems business.

In the Aircraft Sales and Leasing segment, sales decreased $12,060 or 69.3% compared with the prior year. Gross profit in the Aircraft Sales and Leasing segment decreased $24,190 from the prior year primarily as a result of the reduction in aircraft sales and the impairment charge of $21,033 recorded in the second quarter of fiscal 2009 (see Note 11 of Notes to Condensed Consolidated Financial Statements). Earnings from joint ventures increased $2,399 compared to the prior year due to gains on the sale of two aircraft from our joint venture portfolio.

Operating income decreased $16,406 or 52.3% compared with the prior year due to the impairment charge recorded in the Aircraft Sales and Leasing segment and an increase in selling, general and administrative expenses, partially offset by increased gross profit outside of our Aircraft Sales and Leasing segment. Selling, general and administrative expenses increased $7,264 principally reflecting the impact of acquisitions, as well as $800 of severance expense and increased bad debt expense over the prior year of $1,700. Net interest expense increased $462 or 11.5% over the prior year principally due to a reduction in interest income on amounts invested. Our effective income tax rate remained essentially unchanged at 34.5%.

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November 30, 2008

During the second quarter of fiscal 2009, we retired $56,560 of our convertible notes. The notes were retired for $33,263 cash and the gain after consideration of unamortized debt issuance costs was $22,098 which is reported in gain on extinguishment of debt on the condensed consolidated statement of operations (see Note 6 of Notes to Condensed Consolidated Financial Statements).

Also during the second quarter of fiscal 2009, we sold our industrial turbine business, which was classified as a discontinued operation. Loss on the sale of this business, net of tax, was $1,403 (see Note 9 of Notes to Condensed Consolidated Financial Statements).

Income from continuing operations was $21,352 for the second quarter of fiscal 2009 compared to $17,888 in the prior year due to the factors discussed above.

Six-Month Period Ended November 30, 2008

Consolidated sales for the six-months ended November 30, 2008 increased $96,869 or 15.7% over the prior year period. Sales to commercial customers increased 6.4% compared to the prior year reflecting increased sales to commercial customers in each of our segments except Aircraft Sales and Leasing, which experienced a decline. Sales to defense customers increased 32.2% reflecting increased sales to defense customers in the Structures and Systems and Aviation Supply Chain segments.

In the Aviation Supply Chain segment, sales increased $12,104 or 4.2% over the prior year reflecting increased demand for parts support from defense-related performance-based logistics programs and aftermarket parts sales to commercial customers, partially offset by lower sales at our component repair business, reduced sales to a regional airline customer and the unfavorable impact of foreign currency translation. Gross profit in the Aviation Supply Chain segment increased $4,428 or 6.6% primarily due to the increased sales volume, and the gross profit margin percentage increased to 23.8% from 23.3% in the prior year due to the favorable mix of inventories sold.

In the Maintenance, Repair and Overhaul segment, sales increased $42,421 or 32.3% over the prior year. The increase in sales is attributable to the inclusion of revenue from Avborne, which was acquired in March 2008 and contributed approximately $30,000 of revenue during the first six months of fiscal 2009, as well as increased revenues at our landing gear overhaul business and airframe maintenance centers. Gross profit in the Maintenance, Repair and Overhaul segment increased $8,295 or 46.2%, and the gross profit margin percentage increased to 15.1% from 13.7% in the prior year due to increased volume and operational improvement initiatives.

In the Structures and Systems segment, sales increased $75,200 or 48.1% over the prior year. The increase in sales is attributable to the inclusion of revenue from Summa, which was acquired in December 2007 and contributed approximately $56,000 of revenue during the first six months of fiscal 2009, as well as continued strong demand for specialized mobility products. Gross profit in the Structures and Systems segment increased $16,405 or 82.4%, and the gross profit percentage increased to 15.7% from 12.7%, in the prior year due to increased volume and increased shipments of higher margin products.

In the Aircraft Sales and Leasing segment, sales decreased $32,856 or 79.2% compared with the prior year. During the six-months ended November 30, 2008, we sold one aircraft from our wholly-owned aircraft portfolio whereas during the first half of the prior year, we sold three aircraft from our wholly-owned portfolio. Gross profit in the Aircraft Sales and Leasing segment decreased $24,190 from the prior year as a result of the reduction in aircraft sales and the impairment charge of $21,033 recorded in the second quarter of fiscal 2009 (see Note 11 of Notes to Condensed Consolidated Financial Statements). Earnings from joint ventures increased $2,827 compared to the prior year due to gains on the sale of two aircraft held in joint venture.

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November 30, 2008

Operating income decreased $11,516 or 19.8% compared with the prior year due to the impairment charge recorded in the Aircraft Sales and Leasing segment and an increase in selling, general and administrative expenses, partially offset by increased sales and gross profit. Selling, general and administrative expenses increased $13,400 reflecting the impact of acquisitions and increased spending to support marketing efforts. Net interest expense increased $1,014 or 13.0% over the prior year principally due to a reduction in interest income on amounts invested. Our effective income tax rate increased slightly to 34.5% compared to 34.4% in the prior year.

During the second quarter of fiscal 2009, we retired $56,560 of convertible notes. The notes were retired for $33,263 in cash and the gain after consideration of unamortized debt issuance costs was $22,098 which is reported in gain on extinguishment of debt on the condensed consolidated statement of operations (see Note 6 of Notes to Condensed Consolidated Financial Statements).

Also during the second quarter of fiscal 2009, we sold our non-core industrial turbine business, which was classified as a discontinued operation. Loss on the sale of business, net of tax, was $1,403 (see Note 9 of Notes to Condensed Consolidated Financial Statements).

Income from continuing operations was $40,083 for the six-months ended November 30, 2008 compared to $33,143 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. We continually evaluate various financing arrangements, including the issuance of common stock or debt, which would allow us to improve our liquidity position and finance future growth on commercially reasonable terms. Our continuing ability to borrow from our lenders and issue debt and equity securities to the public and private markets in the future may be negatively affected by a number of factors, including general economic conditions, airline 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. Under a universal shelf registration statement filed with the Securities and Exchange Commission that became effective on December 12, 2008, we may offer and sell up to $300,000 of various types of securities, including common stock, preferred stock and medium-term or long-term debt securities, subject to market conditions.

At November 30, 2008, our liquidity and capital resources included cash of $121,764 and working capital of $571,537. Our revolving credit agreement, as amended (the “Credit Agreement”) with various financial institutions, as lenders, and LaSalle Bank National Association, as administrative agent for the lenders, provides us with unsecured revolving borrowing capacity of up to $250,000. Under certain circumstances, we may request an increase to the revolving commitment by an aggregate amount of up to $75,000, not to exceed $325,000 in total. The term of our Credit Agreement extends to August 31, 2011. Borrowings under the Credit Agreement bear interest at the London Interbank Offered Rate (“LIBOR”) plus 100 to 237.5 basis points based on certain financial measurements. Borrowings outstanding under this facility at November 30, 2008 were $75,000, and there were approximately $11,500 of outstanding letters of credit which reduced the availability of this facility. In addition to our domestic facility, we also have $2,885 available under a foreign line of credit.

During the six-month period ended November 30, 2008, our operating activities generated $8,127 of cash principally reflecting net income and depreciation and amortization of $59,620 and an increase in

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November 30, 2008

accounts payable of $10,020. Cash flow from operations was unfavorably impacted by investments in inventories of $28,663 principally to support our aviation supply chain customers and a decrease in accrued liabilities and taxes on income of $25,781.

During the six-month period ended November 30, 2008, our investing activities used $13,687 of cash principally as a result of capital expenditures of $16,697 which principally reflects capacity expansion and capability improvements in our Structures and Systems and Maintenance, Repair and Overhaul segments, partially offset by proceeds from aircraft joint ventures of $3,900.

During the six-month period ended November 30, 2008, our financing activities generated $19,669 of cash which reflects proceeds from borrowings on our revolving credit agreement of $75,000, offset by a reduction in borrowings of $55,378 (see Note 6 of Notes to Condensed Consolidated Financial Statements).

Critical Accounting Policies and Significant Estimates

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

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 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. 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

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November 30, 2008

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 (“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.

During the second quarter of fiscal 2009, we performed a comprehensive review of our aircraft portfolio. The primary objective of this review was to assess the impact of the economic slowdown and credit crisis on market conditions. Based upon that review, and taking into consideration the desire to improve liquidity and generate cash, we made the decision to sell one of the four aircraft acquired before September 11, 2001, and offer two of the remaining three for sale. As a result of this review and taking into consideration our assessment of current market conditions, the Company recorded a $21,033 pre-tax impairment charge to reduce the carrying value of the three aircraft to their net realizable value.

Program Development Costs

In June 2005, we announced that our Cargo Systems business was selected to provide cargo handling systems for the new Airbus A400M Military Transport Aircraft (A400M). We are subcontractor to Pfalz Flugzeugwerke GmbH (PFW) on this Airbus program. Our portion of the revenue from this program is expected to exceed $300,000 through fiscal 2015, based on sales projections of the A400M. As of November 30, 2008, we have incurred approximately $51,000 of costs associated with the engineering and development of the cargo system and have capitalized these costs in accordance with SOP 81-1 “Accounting for Performance of Construction – Type and Certain Production – Type Contracts”. Sales and related cost of sales will be recognized on the units of delivery method. In determining the recoverability of the capitalized program development costs, we have utilized certain judgments and estimates concerning expected revenues and the cost to manufacture the A400M cargo system. Differences between actual results and the assumptions utilized by us may result in us not fully recovering the value of the program development costs, which would unfavorably impact our financial condition and results of operations.

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 rate of return on plan assets.

Our discount rate is determined based on a review of long-term, high quality corporate bonds as of May 31, 2008 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 plan assets may impact the amount of net periodic pension expense recognized in our consolidated statement of operations.

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November 30, 2008

New Accounting Standards

In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157 (SFAS 157) “Fair Value Measurements.” SFAS 157 establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 was effective for fiscal years beginning after November 15, 2007 for financial assets and liabilities, as well as for any other assets that are carried at fair value on a recurring basis in financial statements. In November 2007, the FASB provided a one year deferral of the implementation of SFAS 157 for other non-financial assets and liabilities. We adopted the provisions of SFAS 157 for financial assets and liabilities effective June 1, 2008. The adoption did not have an impact on our results of operations and financial position.

In December 2007, the FASB issued SFAS No. 160 (SFAS 160), “Noncontrolling Interests in Consolidated Financial Statements – an Amendment of ARB 51.” This statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest (minority interest) in a subsidiary and for the deconsolidation of a subsidiary. Upon its adoption, effective for us as of June 1, 2009, noncontrolling interests will be classified as equity in the Company’s financial statements and income and comprehensive income attributed to the noncontrolling interest will be included in the Company’s income and comprehensive income. The provisions of this standard must be applied retrospectively upon adoption. We are currently evaluating the impact of adopting SFAS 160 on our results of operations and financial position.

In December 2007, the FASB issued SFAS No. 141 (revised 2007) (SFAS 141(R)), “Business Combinations.” SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree. The provisions of SFAS 141(R) are effective for our business combinations occurring on or after June 1, 2009.

In March 2008, the FASB issued SFAS No. 161 (SFAS 161), “Disclosures about Derivative Instruments and Hedging Activities.” SFAS 161 amends and expands the disclosure requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, and is effective for fiscal years beginning after November 15, 2008. We do not expect the adoption of SFAS 161 will have a material impact on our results of operations or financial condition.

In May 2008, the FASB issued Staff Position FSP APB 14-1 (FSP APB 14-1), “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” FSP APB 14-1 requires companies that have issued convertible debt that may be settled wholly or partly in cash when converted, to account for the debt and equity components separately. The value assigned to the bond liability is the estimated value of a similar bond without the conversion feature as of the issuance date. The difference between the proceeds for the convertible debt and the amount reflected as a bond liability is recorded as additional paid-in-capital. Interest expense is recorded using the issuer’s comparable debt rate. FSP APB 14-1 will be effective for us beginning June 1, 2009 (fiscal 2010) and will require retrospective application. We continue to review the impact of FSP APB 14-1 on our financial statements, however, we are currently estimating, based on the outstanding convertible notes, the implementation of FSP APB 14-1 will result in a reduction of our convertible notes of approximately $77,000, an increase in capital surplus of approximately $50,000 and an increase in deferred taxes of approximately $27,000. In addition, we expect the implementation of FSP APB 14-1 will reduce our diluted earnings per share by $0.10 to $0.13 per share in fiscal 2010.

Table of Contents

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, 2008.

Item 4 – Submission of Matters to a Vote of Security Holders

Our Annual Meeting of Stockholders was held on October 8, 2008. The following items were acted upon at the meeting.

1) Election of four Class III directors to serve until the 2011 Annual Meeting of Stockholders. Four directors were nominated and elected by the stockholders by the requisite vote.

Directors Nominated and Elected at the Meeting

	Votes For	Votes Withheld
Ronald R. Fogleman	33,935,778	2,554,439
Patrick J. Kelly	34,598,898	1,891,319
Timothy J. Romenesko	34,707,038	1,783,179
Ronald B. Woodard	34,624,725	1,865,492

Continuing Directors
Norman R. Bobins
Michael R. Boyce
James G. Brocksmith, Jr.
Gerald F. Fitzgerald
James E. Goodwin
David P. Storch
Marc J. Walfish

2) Ratification of the appointment of KPMG LLP as the independent registered public accounting firm for the fiscal year ending May 31, 2009.

Votes For		34,074,870
Votes Against		2,364,790
Abstained		50,557

Item 6 – Exhibits

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

		AAR CORP.
		(Registrant)


Date:	December 23, 2008	/s/ RICHARD J. POULTON
		Richard J. Poulton
		Vice President, Chief Financial Officer and Treasurer
		(Principal Financial Officer and officer duly
		authorized to sign on behalf of registrant)


		/s/ MICHAEL J. SHARP
		Michael J. Sharp
		Vice President, Controller and Chief Accounting Officer
		(Principal Accounting Officer)

Exhibit No.	Description		Exhibits

31.	Rule 13a-14(a)/15(d)-14(a) Certifications	31.1	Section 302 Certification dated December 23, 2008 of David P. Storch, Chairman and Chief Executive Officer of Registrant (filed herewith).

		31.2	Section 302 Certification dated December 23, 2008 of Richard J. Poulton, Vice President, Chief Financial Officer and Treasurer of Registrant (filed herewith).

32.	Section 1350 Certifications	32.1	Section 906 Certification dated December 23, 2008 of David P. Storch, Chairman and Chief Executive Officer of Registrant (filed herewith).

		32.2	Section 906 Certification dated December 23, 2008 of Richard J. Poulton, Vice President, Chief Financial Officer and Treasurer of Registrant (filed herewith).

				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	8-20
	Item 2.	Management’s Discussion and Analysis of Financial
			Condition and Results of Operations	21-28
	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 4.	Submission of Matters to a Vote of Security Holders		29
	Item 6.	Exhibits		29

	Signature Page			30
	Exhibit Index			31