0001104659-06-065208.txt : 20061005 0001104659-06-065208.hdr.sgml : 20061005 20061005155111 ACCESSION NUMBER: 0001104659-06-065208 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20060831 FILED AS OF DATE: 20061005 DATE AS OF CHANGE: 20061005 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AAR CORP CENTRAL INDEX KEY: 0000001750 STANDARD INDUSTRIAL CLASSIFICATION: AIRCRAFT & PARTS [3720] IRS NUMBER: 362334820 STATE OF INCORPORATION: DE FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-06263 FILM NUMBER: 061131177 BUSINESS ADDRESS: STREET 1: 1100 N WOOD DALE RD CITY: WOOD DALE STATE: IL ZIP: 60191 BUSINESS PHONE: 6302272000 MAIL ADDRESS: STREET 1: 1100 N WOOD DALE RD CITY: WOOD DALE STATE: IL ZIP: 60191 FORMER COMPANY: FORMER CONFORMED NAME: ALLEN AIRCRAFT RADIO INC DATE OF NAME CHANGE: 19700204 10-Q 1 a06-20640_110q.htm QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(D)

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 August 31, 2006

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		(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 September 30, 2006, there were 36,740,357 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 August 31, 2006

Table of Contents

Part I – FINANCIAL INFORMATION
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets
		Condensed Consolidated Statements of Operations
		Condensed Consolidated Statements of Cash Flows
		Condensed Consolidated Statements of Comprehensive Income
		Notes to Condensed Consolidated Financial Statements
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk
	Item 4.	Controls and Procedures

Part II – OTHER INFORMATION
	Item 1A.	Risk Factors
	Item 6.	Exhibits

	Signature Page
	Exhibit Index

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of August 31, 2006 and May 31, 2006

(In thousands)

	August 31,		May 31,
	2006		2006
	(Unaudited)
Assets:
Current assets:
Cash and cash equivalents	$	119,131	$	121,738
Accounts receivable, less allowances of $6,202 and $6,466, respectively	142,442		136,272
Inventories	245,880		259,570
Equipment on or available for short-term lease	84,897		64,022
Deposits, prepaids and other	12,506		12,986
Deferred tax assets	29,489		29,866
Total current assets	634,345		624,454

Property, plant and equipment, net of accumulated depreciation of $133,167 and $129,896, respectively	74,541		72,637

Other assets:
Goodwill	44,440		44,432
Equipment on long-term lease	134,425		140,743
Investment in joint ventures	26,874		28,498
Other	64,178		68,055
	269,917		281,728
	$	978,803	$	978,819

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

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of August 31, 2006 and May 31, 2006

(In thousands)

	August 31,			May 31,
	2006			2006
	(Unaudited)
Liabilities and stockholders’ equity:
Current liabilities:
Short-term debt	$	1,814		$	161
Current maturities of long-term debt	200			200
Current maturities of non-recourse long-term debt	30,934			1,928
Accounts payable	95,034			97,002
Accrued liabilities	75,679			88,497
Total current liabilities	203,661			187,788

Long-term debt, less current maturities	292,609			293,263
Non-recourse debt	—			25,313
Deferred tax liabilities	29,384			25,357
Other liabilities and deferred income	18,587			24,381
	340,580			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 40,877 and 40,789 shares, respectively	40,877			40,789
Capital surplus	269,323			274,211
Retained earnings	209,177			197,392
Treasury stock, 4,186 and 4,135 shares at cost, respectively	(70,859		)	(69,664		)
Unearned restricted stock awards	—			(6,169		)
Accumulated other comprehensive loss -
Cumulative translation adjustments	(853		)	(739		)
Minimum pension liability	(13,103		)	(13,103		)
	434,562			422,717
	$	978,803		$	978,819

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

AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Operations

For the Three Months Ended August 31, 2006 and 2005

(Unaudited)

(In thousands, except per share data)

	Three Months Ended August 31,
	2006			2005
Sales:
Sales from products	$	197,383		$	165,562
Sales from services	37,812			29,740
Sales from leasing	7,003			4,286
	242,198			199,588

Costs and operating expenses:
Cost of products	162,397			138,903
Cost of services	32,439			22,549
Cost of leasing	4,618			3,454
Cost of sales-impairment charges	7,652			—
Selling, general and administrative and other	25,981			23,901
	233,087			188,807

Gain on sale of product line	5,358			—
Equity in earnings of joint ventures	3,041			205
Operating income	17,510			10,986

Gain on extinguishment of debt	2,927			—

Interest expense	(4,666		)	(4,122		)
Interest income	1,339			459
Income before provision for income taxes	17,110			7,323

Provision for income taxes	5,164			2,065
Income from continuing operations	11,946			5,258

Discontinued operations:
Operating loss, net of tax	(162		)	—
Net income	$	11,784		$	5,258

Earnings per share-basic:
Earnings from continuing operations	$	0.33		$	0.16
Loss from discontinued operations	—			—
Earnings per share - basic	$	0.33		$	0.16

Earnings per share-diluted:
Earnings from continuing operations	$	0.29		$	0.15
Loss from discontinued operations	—			—
Earnings per share - diluted	$	0.29		$	0.15

Weighted average common shares outstanding - basic	36,076			32,961
Weighted average common shares outstanding - diluted	42,893			37,040

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

AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

For the Three Months Ended August 31, 2006 and 2005

(Unaudited)

(In thousands, except per share data)

	Three Months Ended August 31,
	2006			2005
Cash flows from operating activities:
Net income	$	11,784		$	5,258
Adjustments to reconcile net income to net cash provided from (used in) operating activities:
Depreciation and amortization	8,299			6,091
Deferred tax provision	4,405			3,319
Gain on sale of product line	(5,358		)	—
Impairment charges	7,652			—
Gain on extinguishment of debt	(2,927		)	—
Equity in earnings of joint ventures	(3,041		)	—
Changes in certain assets and liabilities:
Accounts and trade notes receivable	581			6,223
Inventories	4,319			(23,893		)
Equipment on or available for short-term lease	(1,410		)	(343		)
Equipment on long-term lease	(3,156		)	(36,577		)
Accounts payable	(1,671		)	17,515
Accrued liabilities and taxes on income	(14,604		)	(10,435		)
Other liabilities	(5,356		)	9,589
Other	(1,368		)	1,555
Net cash used in operating activities	(1,851		)	(21,698		)

Cash flows from investing activities:
Property, plant and equipment expenditures	(5,995		)	(4,695		)
Proceeds from disposal of assets	—			10
Proceeds from sale of product line	6,567			—
Investment in leveraged leases	428			435
Other, primarily investment in aircraft joint ventures	(9,096		)	161
Net cash used in investing activities	(8,096		)	(4,089		)

Cash flows from financing activities:
Proceeds from borrowings	8,916			11,000
Reduction in borrowings	(1,305		)	(11,540		)
Financing costs	(830		)	(133		)
Other, primarily stock option exercises	667			545
Net cash provided from (used in) financing activities	7,448			(128		)
Effect of exchange rate changes on cash	(108		)	(12		)
Decrease in cash and cash equivalents	(2,607		)	(25,927		)
Cash and cash equivalents, beginning of period	121,738			50,338
Cash and cash equivalents, end of period	$	119,131		$	24,411

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

AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income

For the Three Months Ended August 31, 2006 and 2005

(Unaudited)

(In thousands)

	Three Months Ended August 31,
	2006			2005
Net income	$	11,784		$	5,258

Other comprehensive loss -
Foreign currency translation	(114		)	(471		)
Total comprehensive income	$	11,670		$	4,787

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

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

August 31, 2006

(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 August 31, 2006, and the condensed consolidated results of operations, cash flows and comprehensive income for the three-month periods ended August 31, 2006 and 2005. 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 new stock option grants and for the unvested portion of outstanding stock options that were granted prior to the adoption of SFAS No. 123(R), if any. We recognize compensation 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 2 of Notes to Condensed Consolidated Financial Statements for further discussion of the adoption of SFAS 123(R) and the impact on the first quarter of fiscal year 2007.

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 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 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 their 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 we terminate employment for cause. As of August 31, 2006, awards representing 3,533 shares were available for future grant under the Stock Benefit Plan and a total of 4,630 shares have been granted under the Stock Benefit Plan since its inception.

Effective June 1, 2006, we adopted SFAS No. 123(R), using the modified prospective method. Under SFAS No. 123(R) compensation expense is recognized for new 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), if any. Compensation cost is 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 three-month period ended August 31, 2005 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.

The weighted average fair value of stock options granted during the three-month periods ended August 31, 2006 and 2005 was $11.93 and $8.51, 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:

	Three Months Ended
	August 31,
	2006		2005
Risk-free interest rate	5.0	%	4.1	%
Expected volatility of common stock	58.7	%	58.0	%
Dividend yield	0.0	%	0.0	%
Expected option term in years	4.0		4.0

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-month period ended August 31, 2005:

		Three Months Ended
		August 31, 2005
Net income as reported		$	5,258
Add: Stock-based compensation expense included in net income as reported, net of tax		433
Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of tax		(1,401		)
Pro forma net income		$	4,290
Earnings per share – basic:	As reported	$	0.16
	Pro forma	$	0.13
Earnings per share – diluted:	As reported	$	0.15
	Pro forma	$	0.12

The adoption of SFAS No. 123(R) on June 1, 2006 reduced our income from continuing operations for the three-month period ended August 31, 2006 by $60 and had no impact on basic and diluted earnings per share.

The following table summarizes stock option activity for the three-month period ended August 31, 2006:

					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	(56	)	$	9.23
Cancelled	(6	)	$	14.86
Outstanding at August 31, 2006	3,118		$	17.25	4.2	$	15,958
Exercisable at August 31, 2006	3,018		$	17.02	4.0	$	15,958

The total fair value of stock options that vested during the three-month periods ended August 31, 2006 and 2005 was $0 and $1,628, respectively. The total intrinsic value of stock options exercised during the three-month periods ended August 31, 2006 and 2005 was $748 and $248, respectively. The tax benefit realized from stock options exercised during the three-month periods ended August 31, 2006 and 2005 was $0. As of August 31, 2006, we had $1,133 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 August 31, 2006 and 2005 was $687 and $667, respectively.

Restricted share activity during the three-month period ended August 31, 2006 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	(194	)	$	14.16
Forfeited	(1	)	$	15.88
Nonvested at August 31, 2006	611		$	15.62

During the three-month period ended August 31, 2006, 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 August 31, 2006 we had $6,010 of unearned compensation related to restricted shares that will be amortized to expense over a weighted average period of 2.4 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 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 4 – Gain on Sale of Product Line

During the three-month period ended August 31, 2006, 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”.

Note 5 – Inventory

The summary of inventories is as follows:

	August 31,		May 31,
	2006		2006
Raw materials and parts	$	60,451	$	58,421
Work-in-process	30,010		30,651
Purchased aircraft, parts, engines and components held for sale	155,419		170,498
	$	245,880	$	259,570

Note 6 – Supplemental Cash Flow Information

	Three Months Ended August 31,
	2006		2005
Interest paid	$	6,519	$	6,005
Income taxes paid	762		198
Income tax refunds received	377		1,136

Note 7 – 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 August 31, 2006.

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 termination penalties or fees resulted from these terminations.

Note 8 – 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.

The following table provides a reconciliation of the computations of basic and diluted earnings per share information for the three-month periods ended August 31, 2006 and 2005.

	Three Months Ended August 31,
	2006			2005
Income from continuing operations	$	11,946		$	5,258
Loss from discontinued operations, net of tax	(162		)	—
Net income	$	11,784		$	5,258

Basic shares:
Weighted average common shares outstanding	36,076			32,961

Earnings per share – basic:
Earnings from continuing operations	$	0.33		$	0.16
Loss from discontinued operations	—			—
Earnings per share - basic	$	0.33		$	0.16

Net income	$	11,784		$	5,258
Add: After-tax interest on convertible debt	491			306
Net income for diluted EPS calculation	$	12,275		$	5,564

Diluted shares:
Weighted average common shares outstanding	36,076			32,961
Additional shares from the assumed exercise of stock options	499			475
Additional shares from the assumed vesting of restricted stock	341			—
Additional shares from the assumed conversion of convertible debt	5,977			3,604
Weighted average common shares outstanding – diluted	42,893			37,040

Earnings per share – diluted:
Earnings from continuing operations	$	0.29		$	0.15
Loss from discontinued operations	—			—
Earnings per share - diluted	$	0.29		$	0.15

At August 31, 2006 and 2005, respectively, stock options to purchase 1,200 and 1,500 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.

Note 9 –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. 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 three-month periods ended August 31, 2006 and 2005, we were paid $438 and $132, 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 August 31,
	2006		2005
Statement of operations information:
Sales	$	31,775	$	9,580
Income before provision for income taxes	6,213		541

	August 31,		May 31,
	2006		2006
Balance sheet information:
Assets	$	132,762	$	123,177
Debt	75,225		64,934
Members’ capital	53,995		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 August 31, 2006.

Note 10 – 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 are as follows:

	August 31,		May 31,		November 30,
	2006		2006		2001
Net impaired inventory and engines	$	30,100	$	36,000	$	89,600

Proceeds from sales of impaired inventory and engines for the three-month period ended August 31, 2006 and the twelve-month period ended May 31, 2006 were $900 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 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 11 – 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).

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. Sales in this segment are also derived from the repair, overhaul and sale of parts for industrial gas and steam turbine operators and certain military engines. 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 August 31,
	2006		2005
Sales:
Aviation Supply Chain	$	127,516	$	107,111
Maintenance, Repair and Overhaul	49,595		37,972
Structures and Systems	60,363		51,360
Aircraft Sales and Leasing	4,724		3,145
	$	242,198	$	199,588

	Three Months Ended August 31,
	2006			2005
Gross profit:
Aviation Supply Chain	$	22,255		$	19,710
Maintenance, Repair and Overhaul	7,157			5,742
Structures and Systems	7,071			8,337
Aircraft Sales and Leasing	(1,391		)	893
	$	35,092		$	34,682

AAR CORP. and Subsidiaries

Management’s Discussion and Analysis of Financial

Condition and Results of Operations

August 31, 2006

(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.

The table below sets forth consolidated sales and gross profit for our four business segments for the three-month periods ended August 31, 2006 and 2005.

	Three Months Ended August 31,
	2006		2005
Sales:
Aviation Supply Chain	$	127,516	$	107,111
Maintenance, Repair and Overhaul	49,595		37,972
Structures and Systems	60,363		51,360
Aircraft Sales and Leasing	4,724		3,145
	$	242,198	$	199,588

	Three Months Ended August 31,
	2006			2005
Gross profit:
Aviation Supply Chain	$	22,255		$	19,710
Maintenance, Repair and Overhaul	7,157			5,742
Structures and Systems	7,071			8,337
Aircraft Sales and Leasing	(1,391		)	893
	$	35,092		$	34,682

During 2006 and 2005, the worldwide airline industry continued to experience improvement in air traffic as available seat miles, revenue passenger miles and load factors improved. The increase in air traffic has been driven by the recovery in the airline industry from the depressed levels experienced during fiscal 2002 and 2003, and worldwide economic growth. The worldwide airline industry however, continues to be negatively affected by historically high crude oil prices. We expect that many 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 if these trends continue to develop.

Sales to defense customers increased 21.6% during the first quarter of fiscal 2007. The increase in sales has been driven by growing demand for performance-based logistic services and increased 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.

Results of Operations

Three-Month Period Ended August 31, 2006

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

Consolidated sales for the first quarter ended August 31, 2006 increased $42,610 or 21.3% over the first quarter of last year. Each reporting segment experienced double digit sales growth with sales to commercial customers increasing 21.2% and sales to defense customers up 21.6% compared to the prior year. The sales increase to commercial airline customers reflects our expanded presence in global markets and growth in supply chain programs, as well as increased demand for airframe maintenance and landing gear repair by commercial and regional customers. 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 $20,405 or 19.1% 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 $2,545 or 12.9% over the prior year primarily due to increased sales volume, partially offset by an impairment charge recorded in this segment of $4,750 (see Note 10 of Notes to Condensed Consolidated Financial Statements). The gross profit margin percentage decreased to 17.5% from 18.4% in the prior year due to the impairment charge.

In the Maintenance, Repair and Overhaul segment, sales increased $11,623 or 30.6% from the same quarter last year. The increase in sales is primarily attributable to increased demand for airframe maintenance at our Oklahoma and Indianapolis facilities and for landing gear repair and overhaul services. Gross profit in the Maintenance, Repair and Overhaul segment increased $1,415 or 24.6% over the prior year, but the gross profit margin percentage declined slightly to 14.4% from 15.1% due primarily to lower margins at our Indianapolis-based maintenance facility reflecting lower labor utilization.

In the Structures and Systems segment, sales increased $9,003 or 17.5% over the prior year. The increase in sales was primarily due to increased deliveries of mobility products to the U.S. Department of Defense. Subsequent to the close of the quarter, we announced the receipt of a $68,000 order to supply mobility products to the U.S. Air Force. Deliveries will begin in the third quarter of this fiscal year. Gross profit in the Structures and Systems segment declined $1,266 or 15.2% compared to the prior year as the gross profit margin percentage decreased from 16.2% to 11.7% due to the unfavorable mix of products sold.

In the Aircraft Sales and Leasing segment, sales increased $1,579 or 50.2% compared with the prior year, principally due to the sale of an aircraft previously on lease. Our strategy is to build an aircraft portfolio through participation in joint ventures and for our own account. During the first quarter, our joint ventures purchased four aircraft and sold three bringing the total number of aircraft held in joint ventures to 17 (see Note 9 of Notes to Condensed Consolidated Financial Statements). The increase in equity in earnings of joint ventures compared to the prior year is due to the sale of these three aircraft. We also own eight aircraft outside of the joint ventures, purchasing two in the quarter and selling one. Of the eight 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 $2,284 compared to the prior year principally due to the impairment charge of $2,902 taken on an aircraft made available for sale (see Note 10 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 10 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 $6,524 or 59.4% compared with the prior year’s quarter due to increased sales, equity in earnings of 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 quarter, our selling, general and administrative expenses increased $2,080 or 8.7% 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 10.7% compared to 12.0% in the prior year. Net interest expense decreased $336 or 9.2% primarily due to an increase in interest income on higher average invested cash during the period. Our effective income tax rate increased to 30% compared with 28% in the prior year due to lower anticipated tax benefits on export activities.

Income from continuing operations was $11,946 for the first quarter of fiscal 2007 compared to $5,258 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 August 31, 2006, our liquidity and capital resources included cash of $119,131 and working capital of $430,684. 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 creates 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 August 31, 2006. On August 31, 2006, we terminated our secured revolving credit agreement with Merrill Lynch Capital (the “Merrill Credit Agreement”) 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 termination penalties or fees resulted from the terminations. In addition to our domestic facilities, we also have $2,058 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 three-month period ended August 31, 2006, we used $1,851 of cash from operations primarily due to a reduction in accrued liabilities of $19,960 principally reflecting a payment due in the first quarter for equipment acquired during fiscal 2006 to support a supply chain program, as well as interest and incentive compensation payments. Also during the first quarter of fiscal 2007, there was a use of cash from accounts payable of $1,671 and other assets of $1,368. During the three-month period ended August 31, 2006, cash flow from operations benefited from net income and depreciation and amortization of $20,083.

During the three-month period ended August 31, 2006, our investing activities used $8,096 of cash, principally as a result of capital expenditures of $5,995 and investments made in aircraft for joint ventures of $8,204, partially offset by proceeds of $6,567 from the sale of a product line.

During the three-month period ended August 31, 2006, cash provided from financing activities was $7,448, comprised principally of proceeds from borrowings of $8,916, partially offset by a reduction in borrowings of $1,305.

Contractual Obligations and Off-Balance Sheet Arrangements

A summary of contractual obligations and off-balance sheet arrangements as of August 31, 2006 is as follows:

	Payments Due by Period
													After
	Total		8/31/07		8/31/08		8/31/09		8/31/10		8/31/11		8/31/11
On Balance Sheet:
Debt	$	292,809	$	200	$	59,796	$	200	$	200	$	55,058	$	177,355
Non-recourse Debt	30,934		9,220		21,714		—		—		—		—
Bank Borrowings	1,814		1,814		—		—		—		—		—
Interest	94,814		14,390		12,003		8,681		8,681		8,056		43,003

Off Balance Sheet:
Garden City Operating Lease	30,162		1,429		1,464		1,501		1,538		1,577		22,653

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, loss accruals for aviation equipment operating leases 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. 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 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 provisions of SFAS No. 158 are effective for fiscal years beginning after December 15, 2006. Accordingly, we will adopt SFAS No. 158 no later than the beginning of fiscal year 2008. We are currently evaluating the impact the adoption of SFAS No. 158 will have on our consolidated financial statements.

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 are currently evaluating the impact the adoption of FIN No. 48 will have on our consolidated financial statements.

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.

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes to our market risk 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 August 31, 2006. 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 August 31, 2006, 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 first quarter ended August 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

AAR CORP. and Subsidiaries

August 31, 2006

Item 1A – Risk Factors

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

We may not be successful in executing our relocation and transition plan to Goldsboro, North Carolina

During the fourth quarter of fiscal 2006, we acquired a facility in Goldsboro, North Carolina to manufacture cargo handling systems for the new A400M military transport aircraft. During the first quarter of fiscal 2007, we made the decision to transfer all production of our cargo systems division located in Livonia, Michigan to the new facility. Once complete, the new facility will be approximately 185,000 square feet and will include manufacturing and administrative office space. The transition and relocation of cargo handling system manufacturing, and related activities, includes many different elements, including the completion of bargaining with the union at the Livonia, Michigan facility. We have developed a comprehensive transition plan which addresses all requirements of the move. However, we may not be successful in executing our relocation and transition plan, which could adversely affect our results of operations and financial condition.

Item 6 – Exhibits

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

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:	October 5, 2006	/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)

EXHIBIT INDEX

Exhibit No.	Description		Exhibits

10.	Material Contracts	10.1	AAR CORP. Supplemental Key Employee Retirement Plan, as Amended and Restated effective January 1, 2005 (filed herewith).

31.	Rule 13a-14(a)/15(d)-14(a) Certifications	31.1	Section 302 Certification dated October 5, 2006 of David P. Storch, Chairman, President and Chief Executive Officer of Registrant (filed herewith).

		31.2	Section 302 Certification dated October 5, 2006 of Timothy J. Romenesko, Vice President and Chief Financial Officer of Registrant (filed herewith).

32.	Section 1350 Certifications	32.1	Section 906 Certification dated October 5, 2006 of David P. Storch, Chairman, President and Chief Executive Officer of Registrant (filed herewith).

		32.2	Section 906 Certification dated October 5, 2006 of Timothy J. Romenesko, Vice President and Chief Financial Officer of Registrant (filed herewith).

EX-10.1 2 a06-20640_1ex10d1.htm EX-10

Exhibit 10.1

AAR CORP.
SUPPLEMENTAL KEY EMPLOYEE RETIREMENT PLAN

As Amended and Restated Effective January 1, 2005

AAR CORP.
SUPPLEMENTAL KEY EMPLOYEE RETIREMENT PLAN

As Amended and Restated Effective January 1, 2005

TABLE OF CONTENTS

		Page
ARTICLE I	DEFINITIONS	1
ARTICLE II	ELIGIBILITY	6
ARTICLE III	SUPPLEMENTAL RETIREMENT BENEFIT AND SUPPLEMENTAL SURVIVING SPOUSE BENEFIT	7
ARTICLE IV	SUPPLEMENTAL CONTRIBUTIONS	11
ARTICLE V	FORFEITURES	18
ARTICLE VI	ADMINISTRATION OF THE PLAN	19
ARTICLE VII	AMENDMENT OR TERMINATION	20
ARTICLE VIII	GENERAL PROVISIONS	21

AAR CORP.
SUPPLEMENTAL KEY EMPLOYEE RETIREMENT PLAN

As Amended and Restated Effective January 1, 2005

WHEREAS, the AAR CORP. Supplemental Key Employee Retirement Plan (“SKERP”) was adopted effective June 1, 1994, for the Executive Officers, and other designated officers and key employees, of AAR CORP. and its Affiliated Companies who participate in the qualified retirement plans from time to time established and maintained by AAR CORP. The purpose of the Plan is to ensure that the retirement benefits provided to Executive Officers and certain other officers and key employees enhance the overall effectiveness of the AAR CORP. executive compensation program and attract, retain and motivate such individuals;

WHEREAS, the Company amended the Plan on June 1, 1995, January 1, 1996 and June 1, 1996, amended and restated the Plan effective April 11, 2000, and further amended the Plan effective July 1, 2003;

WHEREAS, the Company now desires to further amend the Plan to comply with Code Section 409A and guidance and regulations issued thereunder with respect to benefits earned and vested under the Plan from and after January 1, 2005; and

WHEREAS, benefits under the Plan earned and vested prior to January 1, 2005 shall be administered without giving effect to Code Section 409A and guidance and regulations issued thereunder.

NOW, THEREFORE, the AAR CORP. Supplemental Key Employee Retirement Plan is hereby amended and restated, effective January 1, 2005, as set forth below:

ARTICLE I
DEFINITIONS

Wherever used herein the following terms shall have the meanings hereinafter set forth:

1.1 “Additional Supplemental Company Account” means the account maintained by the Company for a Participant under the Plan that is credited with Additional Supplemental Company Contributions.

1.2 “Additional Supplemental Company Contribution” means the contribution made by the Company for the benefit of a Participant pursuant to Section 4.5 of the Plan.

1.3 “Affiliated Company” means a business entity, or predecessor of such entity, if any, which controls, or is under common control with, the Company.

1.4 “Board” means the Board of Directors of the Company.

1.5 “Change in Control” means:

(a) With respect to a Pre-2005 Benefit the earliest of:

(i) the time any person (as such term is used in Section 13(d) of the Securities Exchange Act of 1934, as amended (“Exchange Act”)), has acquired (other than directly from the Company) beneficial ownership (as that term is defined in Rule 13d-3 under the Exchange Act), of more than 20% of the outstanding capital stock of the Company entitled to vote for the election of directors;

(ii) the effective time of (1) a merger or consolidation or other business combination of the Company with one or more other corporations as a result of which the holders of the outstanding voting stock of the Company immediately prior to such business combination hold less than 60% of the voting stock of the surviving or resulting corporation, or (2) a transfer of substantially all of the assets of the Company other than to an entity of which the Company owns at least 80% of the voting stock; or

(iii) the election, over any period of time, to the Board of Directors of the Company without the recommendation or approval of the incumbent Board of Directors of the Company, of the lesser of (1) three directors, or (2) directors constituting a majority of the number of directors of the Company then in office.

(b) With respect to a Post-2004 Benefit, the earliest of:

(i) the time any person (as such term is used in Section 13(d) of the Exchange Act) has acquired (other than directly from the Company) beneficial ownership (as that term is defined in Rule 13(d)-3 under the Exchange Act) of more than 35% of the outstanding capital stock of the Company entitled to vote for the election of directors;

(ii) the effective time of (1) a merger or consolidation or other business combination of the Company with one or more other corporations as a result of which the holders of the outstanding voting stock of the Company immediately prior to such business combination hold less than 60% of the voting stock of the surviving or resulting corporation, or (2) a transfer of substantially all of the assets of the Company, other than to an entity of which the Company owns at least 80% of the voting stock; or

(iii) the election, over any period of time, to the Board of Directors of the Company, without the recommendation or approval of the incumbent Board of Directors of the Company, of directors constituting a majority of the number of directors of the Company then in office.

1.6 “Code” means the Internal Revenue Code of 1986, as amended from time to time, and any regulations relating thereto.

1.7 “Committee” means the Retirement Committee responsible for the administration of the Qualified Retirement Plan.

1.8 “Company” means AAR CORP., a Delaware corporation, or, to the extent provided in Section 8.11 below, any successor corporation or other entity resulting from a merger or consolidation into or with the Company or a transfer or sale of substantially all of the assets of the Company.

1.9 “Executive Officer” means each of (a) the President and Chief Executive Officer and (b) the Vice President, General Counsel and Secretary of the Company holding office on June 1, 1994. The Compensation Committee of the Board, upon recommendation of management, shall have the discretion from time to time to designate individuals occupying other executive positions with the Company or an Affiliated Company as Executive Officers for purposes of the Plan.

1.10 “Key Employee” means each employee of the Company who may from time to time be designated as such for purposes of the Plan by and in the discretion of the Compensation Committee of the Board, upon recommendation of management.

1.11 “Normal Retirement Date” means the first day of the calendar month coincident with or next following the date a Participant attains age 65.

1.12 “Participant” means any individual who has been designated an Executive Officer or Key Employee of the Company or an Affiliated Company for purposes of the Plan.

1.13 “Plan” means the AAR CORP. Supplemental Key Employee Retirement Plan.

1.14 “Plan Year” means the calendar year or any other 12 consecutive month period that constitutes the fiscal year of the Qualified Profit Sharing Plan.

1.15 “Post-2004 Benefit” means the portion of a Participant’s Supplemental Retirement Benefit and Supplemental Accounts, as applicable, equal to the present value, determined as of a Participant’s date of separation from service after December 31, 2004, of the excess of (a) such Benefit or Account balances to which the Participant would be entitled under the Plan if he separated from service after December 31, 2004, over (b) his Pre-2005 Benefit, and received a full payment of benefits from the Plan on the earliest possible date allowed under the Plan following separation from service pursuant to Articles III and IV, calculated from and after January 1, 2005 to the date of separation from service.

1.16 “Pre-2005 Benefit” means the portion of a Participant’s Supplemental Retirement Benefit and/or Supplemental Profit Sharing Account, Supplemental Company Account and Supplemental Deferral Account, as applicable, equal to the present value of the Benefit or Account balances, determined as of December 31, 2004, to which the Participant would be entitled under the Plan if he voluntarily separated from service without cause on December 31, 2004 and received a full payment of benefits from the Plan on the earliest possible date allowed under the Plan following separation from service pursuant to Articles III and IV, calculated as of December 31, 2004.

1.17 “Qualified Company Account” means the account maintained for a Participant under the Qualified Profit Sharing Plan that is credited with Qualified Company Contributions.

1.18 “Qualified Company Contribution” means the Company Contribution made by the Company or an Affiliated Company for the benefit of a Participant under and in accordance with the terms of the Qualified Profit Sharing Plan in any Plan Year.

1.19 “Qualified Profit Sharing Account” means the account maintained for a Participant under the Qualified Profit Sharing Plan that is credited with Qualified Profit Sharing Contributions.

1.20 “Qualified Profit Sharing Contribution” means the Profit Sharing Contribution made by the Company or an Affiliated Company for the benefit of a Participant under and in accordance with the terms of the Qualified Profit Sharing Plan.

1.21 “Qualified Profit Sharing Plan” means the AAR CORP. Employees’ Profit Sharing Plan, established effective June 1, 1965, and as amended from time to time, and each successor or replacement plan.

1.22 “Qualified Retirement Benefit” means the benefit payable to a Participant pursuant to the Qualified Retirement Plan (including any increased amounts payable with respect to any calendar year as described in Appendix A of the Qualified Retirement Plan) by reason of his separation from service with the Company and all Affiliated Companies for any reason other than death; provided, however, that such benefit shall be determined in accordance with Section 3.1 or Section 3.2 as applicable.

1.23 “Qualified Retirement Plan” means the AAR CORP. Retirement Plan, established effective August 1, 1988, and as amended from time to time, and each successor or replacement plan.

1.24 “Qualified Salary Deferral Account” means the account maintained for a Participant under the Qualified Profit Sharing Plan that is credited with Qualified Salary Deferral Contributions.

1.25 “Qualified Salary Deferral Contribution” means the Salary Deferral Contribution made by the Company or an Affiliated Company for the benefit of a Participant under and in accordance with the terms of the Qualified Profit Sharing Plan in any Plan Year.

1.26 “Qualified Surviving Spouse Benefit” means the aggregate benefit payable to the Surviving Spouse of a Participant pursuant to the Qualified Retirement Plan, and all annuities provided with respect to the Participant under the Qualified Retirement Plan, in the event of the death of the Participant at any time prior to the commencement of payment of his Qualified Retirement Benefit.

1.27 “Specified Employee” means a key employee (as defined in Code Section 416(i) without regard to paragraph (5) thereof), including, without limitation, a Key Employee or an Executive Officer. A Participant shall be deemed to be a Specified Employee with respect to a calendar year if he is a Specified Employee during the 12-month period ending on September 30th of the preceding calendar year.

1.28 “Supplemental Accounts” means, collectively, the Supplemental Profit Sharing Account, the Supplemental Company Account, the Supplemental Company Account #2, the Supplemental Deferral Account and the Additional Supplemental Company Account maintained by the Company for a Participant under the Plan.

1.29 “Supplemental Base Salary Deferral Agreement” means a written agreement entered into by a Participant pursuant to the provisions of Section 4.2.

1.30 “Supplemental Base Salary Deferral Contribution” means the base salary contribution made by the Company for the benefit of a Participant pursuant to Section 4.1 of the Plan in any Plan Year.

1.31 “Supplemental Bonus Deferral Agreement” means a written agreement entered into by a Participant pursuant to the provisions of Section 4.3.

1.32 “Supplemental Bonus Deferral Contribution” means the bonus contribution made by the Company for the benefit of a Participant pursuant to Section 4.1 in any Plan Year.

1.33 “Supplemental Company Account” means the account maintained by the Company for a Participant under the Plan that is credited with Supplemental Company Contributions.

1.34 “Supplemental Company Account #2” means, effective June 1, 2006, the account maintained by the Company for a Participant under the Plan that is credited with Supplemental Company Contributions #2.

1.35 “Supplemental Company Contribution” means the contribution made by the Company for the benefit of a Participant pursuant to Sections 4.4 and 4.5 of the Plan in any Plan Year.

1.36 “Supplemental Company Contribution #2” means, effective June 1, 2006, the contribution made by the Company for the benefit of a Participant pursuant to Section 4.7 of the Plan.

1.37 “Supplemental Deferral Account” means the account maintained by the Company for a Participant under the Plan that is credited with Supplemental Base Salary and Bonus Deferral Contributions.

1.38 “Supplemental Profit Sharing Account” means the account maintained by the Company for a Participant under the Plan that is credited with Supplemental Profit Sharing Contributions.

1.39 “Supplemental Profit Sharing Contribution” means the contribution made by the Company for the benefit of a Participant pursuant to Section 4.6 of the Plan in any Plan Year.

1.40 “Supplemental Retirement Benefit” means the benefit payable to a Participant pursuant to Section 3.1 or 3.2 of the Plan by reason of his separation from service with the

Company and all Affiliated Companies for any reason other than death, or in connection with the termination of the Plan or termination of participation in the Plan.

1.41 “Supplemental Surviving Spouse Benefit” means the benefit payable to a Surviving Spouse pursuant to Section 3.3 of the Plan.

1.42 “Surviving Spouse” means a person who is married to a Participant throughout the one-year period ending on the date of his death.

1.43 “Unforeseeable Emergency” means a severe financial hardship to the Participant resulting from an illness or accident of the Participant, the Participant’s spouse, or a dependent (as defined in Code Section 152(a)) of the Participant, loss of the Participant’s property due to casualty, or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant.

1.44 Except as otherwise provided in this Article I, all defined terms used in the Plan that are defined in the Qualified Retirement Plan or in the Qualified Profit Sharing Plan, as applicable, shall have the same meaning in the Plan as is set forth in the definition in the Qualified Retirement Plan or the Qualified Profit Sharing Plan.

1.45 Words in the masculine gender shall include the feminine and the singular shall include the plural, and vice versa, unless qualified by the context. Any headings used herein are included for ease of reference only and are not to be construed so as to alter the terms hereof.

ARTICLE II
ELIGIBILITY

2.1 Executive Officers. Each Executive Officer shall be a Participant in the Plan with respect to the Supplemental Retirement Benefit and Supplemental Surviving Spouse Benefit set forth in Sections 3.1 and 3.3, and the Supplemental Salary Deferral Contributions, the Supplemental Bonus Deferral Contributions, the Supplemental Company Contributions and the Supplemental Profit Sharing Contributions set forth in Article IV.

2.2 Key Employees. Each Key Employee shall be a Participant in the Plan with respect to the Supplemental Retirement Benefit and the Supplemental Surviving Spouse Benefit set forth in Sections 3.2 and 3.3, and the Supplemental Salary Deferral Contributions, the Supplemental Bonus Deferral Contributions, the Supplemental Company Contributions and the Supplemental Profit Sharing Contributions set forth in Article IV.

2.3 Cessation of Participation. Notwithstanding the foregoing provisions of Section 2.1 or Section 2.2, effective as of October 1, 2001:

(a) No Executive Officer or Key Employee who was not already a Participant in the Plan as of October 1, 2001 shall be eligible to participate in the Plan with respect to the Supplemental Retirement Benefit or Supplemental Surviving Spouse Benefit set forth in Section 3.1, 3.2 and 3.3 of the Plan; and

(b) No Participant who is a Key Employee shall accrue any further Supplemental Retirement Benefit or Supplemental Surviving Spouse Benefit on or after October 1, 2001.

ARTICLE III
SUPPLEMENTAL RETIREMENT BENEFIT AND
SUPPLEMENTAL SURVIVING SPOUSE BENEFIT

3.1 Executive Officers. Effective June 1, 2006:

(a) The Supplemental Retirement Benefit of an Executive Officer who is a Participant as described in Section 2.1 shall be a monthly amount equal to (i) below minus the sum of (ii) and (iii) below:

(i) The monthly amount equal to, in the case of the President and Chief Executive Officer, 1/12th of 60% of Final Average Earnings, without giving effect to the limitations imposed by Code Section 401(a)(17) or any other Code section, or, in the case of all other Executive Officers, the monthly amount equal to 1/12th of 50% of Final Average Earnings (or as otherwise specified in a Compensation Committee resolution designating an individual as an Executive Officer Participant) without giving effect to the limitations imposed by Code Section 401(a)(17) or any other Code section, payable at the Participant’s Normal Retirement Date, and, if applicable, reduced for early commencement as provided in Section 3.6;

LESS

(ii) The monthly amount of the Qualified Retirement Benefit payable to the Participant under the Qualified Retirement Plan at the Participant’s Benefit Commencement Date;

LESS

(iii) The Supplemental Retirement Benefits of the Participant transferred pursuant to Section 4.7.

(b) For purposes of determining the Supplemental Retirement Benefit described above:

(i) The amount described in (a)(i) above for any Participant who commences participation in the Plan after January 1, 2001 shall be multiplied by a fraction, the numerator of which shall be years of Credited Service not to exceed 20, and the denominator of which shall be 20, determined as of the date of the Participant’s separation from service with the Company and all Affiliated Companies.

(ii) A Participant’s Final Average Earnings described in (a)(i) above shall be determined as of October 1, 2001, and shall be adjusted by an amount equal to 25% of the percentage increase in the Participant’s base salary in effect on September 30, 2001 compared to the Participant’s base salary in effect on the date of the Participant’s separation from service for any reason, including Retirement, Disability or death.

(iii) In determining a Participant’s Qualified Retirement Benefit, the Participant’s Cash Account Balance shall not be credited with any Credits for any period of time on or after October 1, 2001, and the Participant shall be deemed to have received his Cash Account Balance on October 1, 2001; and in the case of a Participant who is a Grandfathered Participant, the Grandfathered Benefit shall be calculated considering the Participant’s Final Average Earnings, Credited Service (not in excess of 20 years) and Social Security offset as of October l, 2001.

(iv) The amounts described in (i), (ii) and (iii) shall be computed in the form of an annuity payable over the Participant’s lifetime only.

3.2 Key Employees. Effective as of October 1, 2001, no Participant who is a Key Employee of the Company as described in Section 1.10 shall accrue any further Supplemental Retirement Benefit. The Supplemental Retirement Benefit of a Participant who is such a Key Employee shall be a monthly amount equal to the difference between (a) and (b) below:

(a) The monthly amount of the Qualified Retirement Benefit accrued as of October 1, 2001 to which the Participant would have been entitled under the Qualified Retirement Plan without giving effect to the limitations imposed by Code Section 401(a)(17) or any other Code section;

LESS

(b) The monthly amount of the Qualified Retirement Benefit accrued as of October 1, 2001 and payable to the Participant under the Qualified Retirement Plan at October 1, 2001.

For purposes of determining the Supplemental Retirement Benefit described above:

(i) For calculating the Qualified Retirement Benefit under Section 3.2(a) only, any Key Employee Participant who was over the age of 55 on January 1, 2000 shall be deemed a “Grandfathered Participant” as defined under the Qualified Retirement Plan.

(ii) A Participant’s Final Average Earnings shall be determined as of October 1, 2001, and shall not be based on or include Compensation earned by a Participant after such date.

(iii) In determining a Participant’s Qualified Retirement Benefit, the Participant’s Cash Account Balance shall not be credited with Pay Credits for any period of time on or after October 1, 2001, and in the case of a Participant who is a Grandfathered Participant, the Grandfathered Benefit shall be calculated considering the Participant’s Final Average Earnings, Credited Service (not in excess of 20 years) and Social Security offset as of October 1, 2001.

(iv) The amounts described in (a) and (b) shall be computed in the form of an annuity payable over the Participant’s lifetime only.

3.3 Supplemental Surviving Spouse Benefit. If a Participant described in Section 2.1 or 2.2 dies prior to commencement of payment of his Qualified Retirement Benefit under circumstances in which a Qualified Surviving Spouse Benefit is payable to his Surviving Spouse, then a Supplemental Surviving Spouse Benefit shall be payable under the Plan. The Supplemental Surviving Spouse Benefit shall be paid in a lump sum that is the actuarial equivalent of the amount that would have been payable to the Participant under Section 3.1 or 3.2 at the date of death. Actuarial equivalence shall be determined using the mortality and interest rate assumptions for lump sums then in effect under the Qualified Retirement Plan. The Supplemental Surviving Spouse Benefit shall be paid to the Surviving Spouse within 45 days of the Participant’s death. Notwithstanding the foregoing provisions of this Section 3.3, no Participant who is a Key Employee of the Company as described in Section 2.2 shall accrue any further Supplemental Surviving Spouse Benefit on or after October 1, 2001.

3.4 Form and Time of Commencement of Supplemental Retirement Benefit.

(a) The Supplemental Retirement Benefit of a Participant who terminated employment with the Company and all Affiliated Companies prior to January 1, 2005 shall be paid in the same form, and commencing at the same time, as is applicable to the Qualified Retirement Benefit payable to the Participant. Such Participant’s election under the Qualified Retirement Plan of any optional form of payment, or time for commencement of payment, of his Qualified Retirement Benefit (with the valid consent of his Surviving Spouse where required under the Qualified Retirement Plan) shall also be applicable to the form and time of commencement of payment of his Supplemental Retirement Benefit. Notwithstanding the preceding sentence, an election made by such Participant under the Qualified Retirement Plan with respect to the form or time of commencement of payment of his benefit thereunder following termination of employment, shall not be effective with respect to the form or time of commencement of payment of the Supplemental Retirement Benefit unless (i) such Participant has then attained age 55 and his age plus years of Credited Service is at least equal to 62, (ii) such election is expressly approved in writing by the Company in its sole discretion acting through the AAR CORP. Retirement Committee, and (iii) if such Supplemental Retirement Benefit is to be paid to the Participant in a lump sum distribution, such Participant has agreed in writing to reimburse the Company for such payment amount, plus interest thereon at 8% per annum, immediately upon demand, in the event of forfeiture of benefits under this Article III, pursuant to Article V below. If

any of the criteria specified in the preceding sentence, applicable to the effectiveness of an election made by such Participant under the Qualified Retirement Plan with respect to the form or time of commencement of payment of his Supplemental Retirement Benefit under this Article III is not satisfied, the form and time of commencement of payment under this Article shall be selected by the Company in its sole discretion acting through the AAR CORP. Retirement Committee.

(b) The Supplemental Retirement Benefit of a Participant who terminates employment with the Company and all Affiliated Companies on and after January 1, 2005 shall be paid or commence to be paid to him on the date on which he attains the age of 65 years. Notwithstanding the preceding sentence, such a Participant who has then attained age 55 and whose age plus years of Credited Service is at least equal to 62 shall, at the Participant’s election, be paid or commence to be paid to him either (a) as of the date of his separation from service with the Company and all Affiliated Companies, or (b) as of the first day of a calendar month and year elected by the Participant (which shall be no later than 15 years after the date of his separation from service).

(c) A distribution of a Supplemental Retirement Benefit shall be paid to any Participant in either (i) a single lump sum, or (ii) installments over a number of years (not to exceed 15) payable in monthly, quarterly or annual installments, as elected by the Participant.

(d) Any Participant in the Plan on December 31, 2004 shall make such time and form elections described in paragraphs (b) and/or (c) of this Section on or before December 31, 2005. If a Participant does not make timely elections with respect to the time, if applicable, and form of payment pursuant to paragraphs (b) and/or (c), such payment shall be made to him as of his separation from service in a lump sum. Notwithstanding the preceding provisions of this Section 3.4, a Supplemental Retirement Benefit will not be paid to a Participant in a lump sum unless the Participant has agreed in writing, prior to receipt of the distribution, to reimburse the Company for such payment amount, plus interest thereon at 8% per annum, immediately upon demand, in the event of a forfeiture of his Supplemental Retirement Benefit under this Article III pursuant to Article V below.

(e) Notwithstanding the preceding sentences of this Section 3.4, the single sum value of the Supplemental Retirement Benefit of each Key Employee, determined as of October 1, 2001, under Section 3.2 shall be paid to him as soon as administratively practicable after such date.

3.5 Change in Form or Time of Payment. Notwithstanding any provision of the Plan to the contrary, a Participant may elect distribution of all or any part of the portion of his Pre-2005 Benefit applicable to his Supplemental Retirement Benefit at any time if (a) he elects such distribution by written instrument delivered to the Committee at least six months in advance of the date such distribution is received, or (b) the distribution is subject to a forfeiture penalty

equal to 10% of the amount of the distribution. Such distribution shall be made in a method determined pursuant to Section 3.4.

Notwithstanding any other provisions of the Plan, a Participant may modify his election as to the form or time of distribution of his Post-2004 Benefit applicable to his Supplemental Retirement Benefit if (i) such election does not take effect until at least 12 months after the date on which the election is made, (ii) the first payment with respect to which such election is made is deferred for a period of not less than five years from the date on which such payment would otherwise have been made, and (iii) any election related to a payment to be made at a specified date is made at least 12 months prior to the date of the first scheduled payment.

Notwithstanding any other provisions of this Section 3.5, a Participant may change an election with respect to the time and form of payment of the portion of his Post-2004 Benefit applicable to his Supplemental Retirement Benefit without regard to the restrictions imposed under the preceding paragraph on or before December 31, 2006, provided that such election (1) applies only to amounts that would not otherwise be payable in calendar year 2006, and (2) shall not cause any amount to be paid in calendar year 2006 that would not otherwise be payable in such year.

3.6 Equivalencies. A Supplemental Retirement Benefit that is payable in any form other than an annuity over the lifetime of the Participant only, or that commences at any time prior to the Participant’s Normal Retirement Date, shall be the equivalent of the Supplemental Retirement Benefit determined pursuant to Section 3.1 or 3.2 above, as applicable, based upon the same adjustments and assumptions as those specified in the Qualified Retirement Plan with respect to determination of the amount of the Qualified Retirement Benefit or the date for commencement of payment thereunder.

ARTICLE IV
SUPPLEMENTAL CONTRIBUTIONS

4.1 Supplemental Base Salary and Supplemental Bonus Deferral Contributions. The aggregate Supplemental Base Salary Contribution and Supplemental Bonus Deferral Contribution to be made by the Company for the benefit of a Participant for any Plan Year shall be an amount equal to the difference between (a) and (b) below:

(a) The Qualified Salary Deferral Contribution that would have been withheld and deposited to the Qualified Salary Deferral Account of the Participant for the Plan Year, as determined by the Salary Deferral Agreement between the Participant and the Company or an Affiliated Company in effect for such Year pursuant to the terms of the Qualified Profit Sharing Plan, without giving effect to any limitations imposed by the Code on the Qualified Profit Sharing Plan;

LESS

(b) The amount of the Qualified Salary Deferral Contribution actually allocated to the Qualified Salary Deferral Account of the Participant for the Plan Year.

The aggregate Supplemental Base Salary and Supplemental Bonus Deferral Contributions made for the benefit of a Participant for any Plan Year shall be credited to a Supplemental Deferral Account maintained under the Plan in the name of such Participant at the same time as Qualified Salary Deferral Contributions are made for such Plan Year.

4.2 Supplemental Base Salary Deferral Agreement. As a condition to the Company’s obligation to make a Supplemental Salary Deferral Contribution for the benefit of a Participant pursuant to Section 4.1, the Participant must execute a Supplemental Salary Deferral Agreement in the form attached hereto. Any Participant in the Plan as of December 31, 2004 who was an employee of the Company or an Affiliated Company and a Participant in the Plan as of January 1, 2005 shall deliver to the Committee a Supplemental Salary Deferral Agreement with respect to his base salary earned from and after January 1, 2006 no later than December 31, 2005. An Executive Officer or Key Employee who becomes a Participant on or after January 1, 2005 shall deliver the aforementioned Supplemental Salary Deferral Agreement to the Committee within 30 days after the date the Participant first becomes eligible to participate and such Agreement shall be effective with respect to base salary related to services to be performed subsequent to the election; provided that such Participant shall not be considered first eligible if, on the date he becomes a Participant, he participates in any other nonqualified account balance plan that is subject to Code Section 409A maintained by the Company or an Affiliated Company. If the individual referred to in the preceding sentence does not deliver the aforementioned written Supplemental Salary Deferral Agreement to the Committee within such 30 day period, he shall be entitled to deliver to the Committee a written Supplemental Salary Deferral Agreement with respect to his base salary earned from and after the first day of the Plan Year next following the Plan Year in which the Agreement is delivered. Any election made pursuant to a written Supplemental Salary Deferral Agreement delivered pursuant to the preceding sentences shall continue in effect until revoked by a Participant by notice delivered to the Committee no later than the last day of the Plan Year immediately preceding the first day of the Plan Year in which such election is to become effective, and as of each December 31 the election shall become irrevocable with respect to base salary payable with respect to services performed by the Participant in the immediately following calendar year.

4.3 Supplemental Bonus Deferral Agreement. As a condition to the Company’s obligation to make a Supplemental Bonus Deferral Contribution for the benefit of a Participant pursuant to Section 4.1, the Participant must execute a Supplemental Bonus Deferral Agreement in the form or forms attached hereto. Except as set forth below with respect to a performance based bonus (as defined in Code Section 409A and guidance and regulations thereunder), a Supplemental Bonus Deferral Agreement related to a bonus earned by a Participant during a fiscal year of the Company shall be delivered to the Committee no later than the last day of the preceding fiscal year of the Company. A Supplemental Bonus Deferral Agreement with respect to a performance based bonus shall be delivered to the Company no later than the date six months after the first day of the fiscal year of the Company in which such performance based bonus is earned. A Supplemental Bonus Deferral Agreement shall only be effective with respect to the bonus specified in such Agreement.

4.4 Supplemental Company Contributions. The Supplemental Company Contribution to be made by the Company for the benefit of a Participant for any Plan Year shall be an amount equal to the difference between (a) and (b) below:

(a) The Qualified Company Contribution that would have been allocated to the Qualified Company Account of the Participant for the Plan Year without giving effect to any limitations imposed by the Code on the Qualified Profit Sharing Plan;

LESS

(b) The amount of the Qualified Company Contribution actually allocated to the Qualified Company Account of the Participant for the Plan Year.

A Supplemental Company Contribution made for the benefit of a Participant for any Plan Year shall be credited to a Supplemental Company Account maintained under the Plan in the name of such Participant at the same time as Qualified Company Contributions are made for such Plan Year.

4.5 Additional Supplemental Company Contributions. The Compensation Committee of the Board may at any time, in its discretion, designate any Participant to receive the benefit of an Additional Supplemental Company Contribution from time to time in amounts specified by resolution of the Compensation Committee.

Any Additional Supplemental Company Contributions to be made for the benefit of a Participant shall be credited to an Additional Supplemental Company Account maintained under the Plan under the name of such Participant as and when specified in the Compensation Committee resolution authorizing and directing the Additional Supplemental Company Contributions. Such Additional Supplemental Company Contributions shall be held, administered and invested hereunder in the same manner as regular Supplemental Contributions. The terms of any such Additional Supplemental Company Contributions shall be reflected on an appendix to the Plan.

4.6 Supplemental Profit Sharing Contributions. The Supplemental Profit Sharing Contribution to be made by the Company for the benefit of a Participant for any Plan Year shall be an amount equal to the difference between (a) and (b) below:

(a) The Qualified Profit Sharing Contribution that would have been allocated to the Qualified Profit Sharing Account of the Participant for the Plan Year without giving effect to any limitations imposed by the Code on the Qualified Profit Sharing Plan;

LESS

(b) The amount of the Qualified Profit Sharing Contribution actually allocated to the Qualified Profit Sharing Account of the Participant for the Plan Year.

A Supplemental Profit Sharing Contribution made for the benefit of a Participant for any Plan Year shall be credited to a Supplemental Profit Sharing Account maintained under the Plan in the name of such Participant at the same time as Qualified Profit Sharing Contributions are made for such Plan Year.

4.7 Supplemental Company Contributions #2. During Fiscal Year 2006, 33-1/3% of the Supplemental Retirement Benefit of each Executive Officer who is then an active employee of the Company or an Affiliated Company and a Participant shall be converted to an equivalent single sum, based upon the benefit accrued as of Fiscal Year 2006 and the lump sum settlement rate assumptions applicable during the second calendar quarter of Fiscal Year 2006, and otherwise based upon the same adjustments and assumptions as those then specified in the Qualified Retirement Plan. This single sum shall be transferred on or after May 1, 2006 to a Supplemental Company Account #2 established for the Participant that shall be held, administered and invested under Article IV of the Plan, and be subject to the remaining applicable provisions of the Plan, except as otherwise required by Code Section 409A.

During Fiscal Year 2007, 50% of the Supplemental Retirement Benefit of each Executive Officer who is then an active employee of the Company or an Affiliated Company and a Participant shall be converted to an equivalent single sum, based upon the benefit accrued as of Fiscal Year 2006 and the lump sum settlement rate assumptions applicable during the second calendar quarter of Fiscal Year 2006, and otherwise based upon the same adjustments and assumptions as those then specified in the Qualified Retirement Plan. This single sum shall be transferred on or after September 1, 2006 to a Supplemental Company Account #2 established for the Participant that shall be held, administered and invested under Article IV of the Plan, and be subject to the remaining applicable provisions of the Plan, except as otherwise required by Code Section 409A.

During Fiscal Year 2008, 100% of the Supplemental Retirement Benefit of each Executive Officer who is then an active employee of the Company or an Affiliated Company and a Participant shall be converted to an equivalent single sum, based upon the benefit accrued as of Fiscal Year 2006 and the lump sum settlement rate assumptions applicable during the second calendar quarter of Fiscal Year 2006, and otherwise based upon the same adjustments and assumptions as those then specified in the Qualified Retirement Plan. This single sum shall be transferred on or after June 1, 2007 to a Supplemental Company Account #2 established for the Participant that shall be held, administered and invested under Article IV of the Plan, and be subject to the remaining applicable provisions of the Plan, except as otherwise required by Code Section 409A.

4.8 Investment of Supplemental Contributions.

(a) Investments. Amounts credited hereunder to the Supplemental Accounts of a Participant shall be treated as if they were actually invested in various investment funds that are made available by the Committee from time to time and as are designated by each Participant pursuant to investment directions given to the Committee. Such Accounts shall be credited with earnings, gains and losses of the applicable investment funds on the last day of each calendar quarter or on such other date selected

by the Committee. Investment directions shall be made by a Participant in specified multiples of 10%.

(b) Investment Changes. Each Participant shall have the right to direct the Committee to modify his investment directions made pursuant to paragraph (a) above with respect to amounts credited to his Supplemental Accounts after the date such modification direction becomes effective, in specified multiples of 10%. Each Participant shall also have the right to direct the Committee to change the investment directions made pursuant to paragraph (a) above with respect to amounts credited to his Accounts on the date such direction to change becomes effective, in specified multiples of 10%.

(c) Effective Date of Investment Direction. Any investment direction, or modification or change of an investment direction, made pursuant to paragraph (a) or (b) above, shall be effective as soon as practicable after (and in any event not later than the first day of the month that occurs at least 30 days after) the date the applicable direction is given to the Committee. A modification or change of an investment direction made pursuant to paragraph (b) may, if required by an administrative rule promulgated by the Committee, be made only once in each calendar quarter.

In the event that the sponsor of the investment funds permits more frequent fund transfers than permitted above, or does not require written direction to authorize fund transactions, the Committee may waive or modify the requirements set forth in the preceding provisions of this Section as it deems appropriate.

(d) Investment Funds. Any investments made by the Company or by the Trustee of Trust Agreement No. 2 referred to in paragraph (f) below to conform to directions made by a Participant pursuant to this Section shall be in investment funds maintained in the name of the Company, or in the name of such Trustee, and no Participant shall at any time have any interest in the assets of any such investment fund.

(e) Statement of Accounts. A statement of accounts for each Participant, showing contributions, earnings, gains and losses and current balances of the Accounts provided for under this Article IV shall be provided to each Participant on not less than a quarterly basis.

(f) Trust Agreement No. 2. Notwithstanding the preceding provisions of this Section, during the existence of Trust Agreement No. 2 referred to in Section 8.3, the Company shall direct the Trustee of Trust Agreement No. 2 to invest and reinvest amounts to conform to directions made by a Participant pursuant to the preceding provisions of this Section 4.8. Directions shall be given by the Company to the Trustee of Trust Agreement No. 2 as soon as practicable after such directions are given to the Company by the Participant.

4.9 Distributions.

(a) Separation From Service Prior to Death. Following a Participant’s separation from service with the Company and all Affiliated Companies for any reason other than death, a Participant shall receive a distribution of all amounts credited to his Supplemental Accounts, including gains and losses credited in accordance with Section 4.8.

(b) Distribution Due to Death. If a Participant dies before distribution to him of the full amount of his Supplemental Accounts, any remaining amount shall be distributed to his beneficiary designated under the Qualified Profit Sharing Plan. If a Participant has not designated a beneficiary under the Qualified Profit Sharing Plan, or if no designated beneficiary is living on the date of distribution hereunder, amounts distributable pursuant to this paragraph shall be distributed to those persons or entities entitled to receive distributions of the Participant’s accounts under the Qualified Profit Sharing Plan.

(c) Unforeseeable Emergency Distribution. A Participant shall be entitled to request a distribution from his Supplemental Deferral Account, prior to his separation from service with the Company and all Affiliated Companies, in order to satisfy an Unforeseeable Emergency. Such a distribution may also include amounts necessary to pay federal, state or local income taxes or penalties reasonably anticipated to result from a distribution applicable to the Participant’s Post-2004 Benefit. Except with respect to eligibility for such a distribution, the procedures for requesting and receiving such a distribution shall satisfy the requirements set forth in the Qualified Profit Sharing Plan with respect to a hardship distribution from his Qualified Salary Deferral Account. A request for a distribution pursuant to this paragraph shall be made separate and apart from a request for a distribution under the Qualified Profit Sharing Plan, and a request for a hardship distribution under the Qualified Profit Sharing Plan shall not automatically be deemed a request for a distribution hereunder.

(d) Time and Form of Payment of Supplemental Accounts. Payment of the balance of a Participant’s Supplemental Accounts shall be paid or commence to be paid to him either (i) as of the date of his separation from service with the Company and all Affiliated Companies, or (ii) as of the first day of a calendar month and year elected by the Participant (which shall be no later than 15 years after the date of his separation from service). Such distribution shall be paid or commence to be paid to the Participant in either (1) a single lump sum, or (2) installments over a number of years (not to exceed 15) payable in monthly, quarterly or annual installments, as elected by the Participant. Any Participant in the Plan on December 31, 2004 shall make such time and form elections on or before December 31, 2005. If a Participant does not make timely elections with respect to the time or form of payment pursuant to the preceding sentence, such payment shall be made to him as of his separation from service in a lump sum. Notwithstanding the preceding sentence, in the case of an Executive Officer or Key Employee who becomes a Participant on or after January 1, 2005, the aforementioned elections with respect to the time and form of payment shall be made within 30 days after

the individual first becomes eligible to participate and such elections shall be effective with respect to the portion of his Supplemental Accounts related to services to be performed subsequent to the election; provided that any portion of such Accounts related to services performed prior to the election shall be payable to him in a single lump sum as of his date of separation from service; and provided further that such an individual shall not be considered first eligible if, on the date he becomes a Participant, he participates in any other nonqualified account balance plan that is subject to Code Section 409A maintained by the Company or any Affiliated Company.

(e) Notwithstanding any provision in the Plan to the contrary, a Participant may elect a distribution of all or any portion of his Pre-2005 Benefit applicable to the amounts credited to his Supplemental Deferral Account, his Supplemental Company Account, and his Supplemental Profit Sharing Account, including gains and losses credited to the date of distribution in accordance with Section 4.8, at any time if (i) he elects such distribution by written instrument delivered to the Committee at least six months in advance of the date such distribution is received, or (ii) the distribution is subject to a forfeiture penalty equal to 10% of the amount of the distribution. Such distribution shall be made in a method determined pursuant to Section 4.9(d).

(f) Notwithstanding any other provision of this Section 4.9, a Participant may modify his election as to the form or time of distribution of all or any portion of his Post-2004 Benefit applicable to amounts credited to his Supplemental Accounts, and earnings thereon, if (i) such election does not take effect until at least 12 months after the date on which the election is made, (ii) the first payment with respect to which such election is made is deferred for a period of not less than five years from the date on which such payment would otherwise have been made, and (iii) any election related to a payment to be made at a specified date is made at least 12 months prior to the date of the first scheduled payment.

Notwithstanding any other provision of this Section 4.9, a Participant may change an election with respect to the time and form of payment of such portion of his Post-2004 Benefit, without regard to the restrictions imposed under the preceding paragraph on or before December 31, 2006; provided that such election (1) applies only to amounts that would not otherwise be payable in calendar year 2006, and (2) shall not cause an amount to be paid in calendar year 2006 that would not otherwise be payable in such year.

(g) Notwithstanding any provision in the Plan to the contrary, in the event of a potential Change in Control of the Company, as determined solely by the Board in its discretion, the portion of the Pre-2005 Benefit applicable to all amounts credited to each Participant’s Supplemental Salary Account, his Supplemental Company Account, and his Supplemental Profit Sharing Account, including gains and losses credited to the date of distribution in accordance with Section 4.8, shall be distributed to him in a lump sum as soon as practicable following the date of such determination by the Board.

(h) Notwithstanding any provision in the Plan to the contrary, the following provisions shall apply, prior to January 1, 2008, to the amounts credited to such Participant’s Supplemental Accounts on or before March 21, 2006 following the first to occur of: (i) a drop in the overall credit rating of the Company below S&P BB or Moody’s Ba; (ii) a drop in the Company’s market capitalization below $75 million for five consecutive trading days; (iii) a drop in the aggregate of cash and existing available bank lines of the Company below $35 million; and (iv) receipt of a notice of material adverse change under any of the Company’s then existing debt agreements:

(i) During the 30-day period commencing on the date an event described in clause (i), (ii), (iii), or (iv) occurs, the Company, in its sole discretion, may distribute all or any part of such portion of a Participant’s Benefit credited to his Supplemental Accounts on or before March 21, 2006 , including gains and losses credited in accordance with Section 4.8 to the date of distribution, to him in a lump sum as the Company deems appropriate and in the best interest of the Company.

(ii) No distribution due to the occurrence of an event described in clause (i), (ii), (iii), or (iv) shall be made from and after the 30th day following the date of such event.

(iii) Following the expiration of the 30-day period after the date of an event described in clause (i), (ii), (iii), or (iv), a Participant shall continue to accrue benefits pursuant to Article III if he is an Executive Officer, and make deferrals and receive contributions pursuant to Article IV.

(iv) The Company shall be entitled to make separate decisions in accordance with clause (i) with respect to the interests of each Participant hereunder.

(i) In no event may a Participant borrow amounts credited to the Accounts maintained for him pursuant to this Article IV.

ARTICLE V
FORFEITURES

5.1 Forfeiture of Supplemental Benefit, Supplemental Surviving Spouse Benefit and Supplemental Company Account #2. Notwithstanding any other provisions of the Plan, (a) if the employment of a Participant with the Company and all Affiliated Companies terminates due to Cause, or (b) if a Participant during his employment with the Company and all Affiliated Companies or at any time during the one-year period after the termination of such employment, violates the covenant not to compete with the Company and its Affiliated Companies set forth in Section 5.3, all rights of the Participant and his Surviving Spouse to a Supplemental Retirement Benefit or a Supplemental Surviving Spouse Benefit, and to a Supplemental Company Account #2, shall be forfeited and shall be retained by the Company free of any and all claims

of the Participant, his Surviving Spouse or any other person claiming with respect to the Participant or his Surviving Spouse.

5.2 Termination For Cause. For purposes of this Section, a termination for Cause shall mean termination of a Participant’s employment by the Company or any Affiliated Company because of (a) the Participant’s conduct, involving theft, embezzlement or fraud, or (b) the Participant’s willful misconduct in the performance of his duties that materially injures the Company or any Affiliated Company, as determined by the Board.

5.3 Covenant Not to Compete. A Participant shall not, during the term of the Participant’s employment with the Company and all Affiliated Companies, and for a period of one year thereafter, without the Company’s express written consent, directly or indirectly, alone or as a member of a partnership, group, or joint stock venture, or as an employee, officer, director or stockholder of any corporation, or in any capacity (a) engage in any activity which is competitive with any of the businesses conducted by the Company or its Affiliated Companies from time to time or at any time during the Participant’s term of employment, provided that the foregoing provision shall not be deemed to prohibit the Participant from purchasing for investment any securities or interest in any publicly-owned organization which is competitive with the business of the Company and its Affiliated Companies, so long as the Participant’s investment in such organization does not exceed the lesser of one percent of its total outstanding equity securities or Two Hundred Fifty Thousand Dollars ($250,000); (b) solicit in connection with any activity which is competitive with any of the businesses of the Company and its Affiliated Companies, any customers or suppliers of the Company and its Affiliated Companies; (c) use the name “AAR” or any variant thereof; or (d) actively solicit, directly or indirectly, any employee or induce any customer or supplier of the Company or any of its Affiliated Companies to terminate or materially change such relationship.

5.4 In the event of a Participant’s separation from service with the Company under circumstances which trigger Change in Control employment termination benefits under the change in control provisions of an employment agreement or severance and change in control agreement between the Participant and the Company, the provisions of subsections 5.1, 5.2 and 5.3 above shall be deemed waived by the Company and null and void.

ARTICLE VI
ADMINISTRATION OF THE PLAN

6.1 Administration by the Committee. The Committee shall be responsible for the general operation and administration of the Plan and for carrying out the provisions thereof.

6.2 General Powers of Administration. All provisions set forth in the Qualified Retirement Plan with respect to the administrative powers and duties of the Committee, expenses of administration, and procedures for filing claims, shall also be applicable with respect to the Plan. The Committee shall be entitled to rely conclusively upon all tables, valuations, certificates, opinions and reports furnished by any actuary, accountant, controller, counsel or other person employed or engaged by the Committee with respect to the Plan.

ARTICLE VII
AMENDMENT OR TERMINATION

7.1 Amendment or Termination. The Company intends the Plan to be permanent but reserves the right to amend or terminate the Plan when, in the sole opinion of the Company, such amendment or termination is advisable. Any such amendment or termination shall be made pursuant to a resolution of the Board and shall be effective as of the date of such resolution or such later date as the resolution may expressly state.

7.2 Effect of Amendment or Termination. No amendment or termination of the Plan shall (a) directly or indirectly deprive any current or former Participant or Surviving Spouse of all or any portion of any Supplemental Retirement Benefit or Supplemental Surviving Spouse Benefit, the right to which has accrued prior to the effective date of such amendment or termination, or which would be payable if the Participant terminated employment for any reason, including death, on such effective date, or (b) directly or indirectly reduce the balance of any Supplemental Deferral Account, Supplemental Company Account or Supplemental Profit Sharing Account held hereunder as of the effective date of such amendment or termination. Upon termination of the Plan, distribution of Supplemental Retirement Benefits and Supplemental Surviving Spouse Benefits, and of amounts in Supplemental Deferral Accounts, Supplemental Company Accounts and Supplemental Profit Sharing Accounts shall be made to Participants, their Surviving Spouses or beneficiaries as soon as administratively feasible following the date of Plan termination, and within the timeframe permitted by regulations issued under Code Section 409A, in the manner described in Sections 3.4 and 4.9(d) of the Plan, except that payment of his Post-2004 Benefit shall be made only at the time set forth in Sections 3.4 and 4.9(d) unless otherwise permitted by regulations issued under Code Section 409A. No additional Supplemental Retirement Benefits or Supplemental Surviving Spouse Benefits shall be earned after termination of the Plan, and no additional credits of Supplemental Salary Reduction Contributions, Supplemental Company Contributions or Supplemental Profit Sharing Contributions shall be made to the accounts of Participants after termination of the Plan, but the Company shall continue to credit gains and losses to accounts pursuant to Section 4.8 until the balances of such accounts have been fully distributed to Participants or their beneficiaries.

7.3 Effect of a Change in Control. Notwithstanding subsections 7.1 and 7.2 above, in the event of a Change in Control, (i) the SKERP shall continue in effect as to any Participant or Surviving Spouse who is a Participant or Surviving Spouse immediately prior to a Change in Control, and (ii) no amendment to or termination of the Plan shall be effective as to any such Participant or Surviving Spouse to the extent the effect of such amendment or termination would be to reduce such Participant’s or Surviving Spouse’s benefits or rights under the Plan from those available to Participant under the Plan immediately prior to any such amendment or termination.

7.4 Termination of Participation. The Company, in its sole discretion, shall have the right to terminate the participation in the Plan or any portion thereof of any Executive Officer or Key Employee whose initial participation in the Plan was designated by the Compensation Committee, upon recommendation of management. Upon such termination of participation, distribution of the Supplemental Retirement Benefit, Supplemental Surviving Spouse Benefit,

and amounts in the Supplemental Accounts, as applicable, to such Participant, determined as of the date of termination of participation, shall be made to such Participant, his Surviving Spouse or beneficiaries either (a) in the manner and at the time described in Articles III and IV of the Plan, or (b) in the sole discretion of the Company, only with respect to the part of the Pre-2004 Benefit applicable to such Benefit and Accounts, in a lump sum payment as soon as practicable following such termination of participation. No additional Supplemental Retirement Benefit or Surviving Spouse Benefit shall be earned by such Participant after termination of his participation in the Plan with respect to such benefits, and no additional credits of Supplemental Salary Deferral Contributions, Supplemental Company Contributions or Supplemental Profit Sharing Contributions shall be made to the Accounts of such Participant after termination of his participation in the Plan with respect to such benefits, but the Company shall continue to credit earnings, gains and losses to existing Accounts of such Participant pursuant to Section 4.8 until the balances of such Accounts have been fully distributed to the Participant or his beneficiaries.

ARTICLE VIII
GENERAL PROVISIONS

8.1 Specified Employee. Notwithstanding any other provision of the Plan, in no event will distribution of a Participant’s Post-2004 Benefit begin earlier than six months following separation from service, unless due to such Participant’s disability or death, if the Participant was a Specified Employee of the Company or an Affiliated Company, at a time during which the Company’s capital stock or capital stock of an Affiliated Company is publicly traded on an established securities market, in the calendar year of his separation from service.

If a Specified Employee will receive payments hereunder in the form of installments, the first payment made as of the date six months after the date of the Participant’s separation from service with the Company and all Affiliated Companies shall be a lump sum, paid as soon as practicable after the end of such six-month period, that includes all payments that would otherwise have been made during such six-month period. From and after the end of such six-month period, any such installment payments shall be made pursuant to the terms of the applicable installment form of payment.

8.2 Participants’ Rights Unsecured. Except as set forth in Section 8.3, the Plan at all times shall be entirely unfunded and no provision shall at any time be made with respect to segregating any assets of the Company or an Affiliated Company for payment of any benefits hereunder. The right of a Participant or his Surviving Spouse or beneficiary to receive a benefit hereunder shall be an unsecured claim against the general assets of the Company, and neither the Participant nor a Surviving Spouse or beneficiary shall have any rights in or against any specific assets of the Company or any Affiliated Company. All amounts credited to Supplemental Salary Deferral Accounts, Supplemental Company Accounts and Supplemental Profit Sharing Accounts of Participants shall constitute general assets of the Company.

8.3 Trust Agreement. Notwithstanding the provisions of Section 8.2, the Company, promptly after the Plan effective date, shall enter into a trust agreement (“Trust Agreement”) with a bank or trust company (with a combined capital and surplus in excess of $100 million dollars), located in the Continental United States, as trustee, whereby the Company shall agree to

contribute to a trust (“Trust”) initially and annually thereafter, for the purpose of accumulating assets actuarially sufficient to satisfy accrued obligations to Participants and Surviving Spouses under Article III hereof, in the event of a Change in Control of the Company. The Trust Agreement shall obligate the Company to make contributions sufficient to satisfy the obligations to Participants, and Surviving Spouses under Article III hereof; provided, however, that such initial contribution shall be made within ten days after the date the Board, in its discretion, deems a Change in Control of the Company likely to occur. The discretion of the Board shall be binding and conclusive with respect to the likelihood of a Change in Control of the Company to occur. Such Trust Agreement shall be substantially in the form of the model trust agreement set forth in Internal Revenue Service Revenue Procedure 92-64, or any subsequent Internal Revenue Service Revenue Procedure, and shall include provisions required in such model trust agreement that all assets of the Trust shall be subject to the creditors of the Company in the event of insolvency. Notwithstanding the provisions of Section 8.2, the Company, on or as soon as practicable after January 1, 1996, shall enter into a Trust Agreement (“Trust Agreement No. 2”) with a bank or trust company (with a combined capital and surplus in excess of $100,000,000) located in the continental United States as Trustee, whereby the Company shall agree to contribute to a trust (“Trust No. 2”) initially and annually thereafter for the purpose of accumulating assets sufficient to provide for Supplemental Salary Deferral Contributions, Supplemental Company Contributions and Supplemental Profit Sharing Contributions with respect to Participants under Article IV hereof. Trust Agreement No. 2 shall be substantially in the form of the model trust agreement set forth in Internal Revenue Service Procedure 92-64, or any subsequent Internal Revenue Service Procedure, and shall include provisions required in such model trust agreement that all assets of Trust No. 2 shall be subject to the creditors of the Company in the event of insolvency. Trust Agreement No. 2 shall include such provisions as are applicable with respect to the investment and reinvestment of such Contributions pursuant to directions given by Participants to the Company and transmitted by the Company to the Trustee of Trust Agreement No. 2 pursuant to paragraph (f) of Section 4.8.

8.4 General Conditions. Except as otherwise expressly provided herein, all terms and conditions of the Qualified Retirement Plan applicable to a Qualified Retirement Benefit, or a Qualified Surviving Spouse Benefit, shall also be applicable to a Supplemental Retirement Benefit or a Supplemental Surviving Spouse Benefit payable hereunder, and all terms and conditions of the Qualified Profit Sharing Plan applicable to a Qualified Salary Deferral Contribution, a Qualified Company Contribution or a Qualified Profit Sharing Contribution shall also be applicable to a Supplemental Salary Deferral Contribution, Supplemental Company Contribution or Supplemental Profit Sharing Contribution to be made hereunder. Any Qualified Retirement Benefit or Qualified Surviving Spouse Benefit or any other benefit payable under the Qualified Retirement Plan shall be paid solely in accordance with the terms and conditions of the Qualified Retirement Plan, any Qualified Salary Deferral Contribution, Qualified Company Contribution or Qualified Profit Sharing Contribution, or any other contribution to be made under the Qualified Profit Sharing Plan shall be made solely in accordance with the terms and conditions of the Qualified Profit Sharing Plan, and nothing in the Plan shall operate or be construed in any way to modify, amend or affect the terms and provisions of the Qualified Retirement Plan or the Qualified Profit Sharing Plan.

8.5 No Guaranty of Benefits. Nothing contained in the Plan shall constitute a guaranty by the Company, any Affiliated Company, or any other person or entity that the assets of the Company or any Affiliated Company will be sufficient to pay any benefit hereunder. No Participant, Surviving Spouse or beneficiary shall have any right to receive a benefit or a distribution of contributions under the Plan except in accordance with the terms of the Plan.

8.6 No Enlargement of Employee Rights. Establishment of the Plan shall not be construed to give any Participant the right to be retained in the service of the Company or any Affiliated Company.

8.7 Spendthrift Provision. No interest of any person or entity in, or right to receive a distribution under, the Plan shall be subject in any manner to sale, transfer, assignment, pledge, attachment, garnishment, or other alienation or encumbrance of any kind; nor may such interest or right to receive a distribution be taken, either voluntarily or involuntarily for the satisfaction of the debts of, or other obligations or claims against, such person or entity, including claims for alimony, support, separate maintenance and claims in bankruptcy proceedings.

8.8 Applicable Law. The Plan shall be construed and administered under the laws of the State of Illinois except to the extent preempted by federal law.

8.9 Small Benefits. If the actuarial value of any Supplemental Retirement Benefit or Supplemental Surviving Spouse Benefit is $5,000 or less, the Company may pay the actuarial value of such Benefit to the Participant or Surviving Spouse in a single lump sum in lieu of any further Benefit payments hereunder. Notwithstanding the preceding sentence, in no event may a distribution be made to a Participant pursuant to this section with respect to the portion of a Participant’s Post-2004 Benefit applicable to his Supplemental Retirement Benefit unless (a) payment accompanies the termination of the Participant’s entire interest in his benefits under Article III of the Plan and his interest under all other nonqualified non-account balance plans subject to Code Section 409A maintained by the Company or any Affiliated Company, and (b) the payment is made on or before the later of December 31 of the calendar year in which occurs the Participant’s separation from service with the Company and all Affiliated Companies, or the 15th day of the third month following such separation from service.

8.10 Incapacity of Recipient. If any person entitled to a payment under the Plan is deemed by the Company to be incapable of personally receiving and giving a valid receipt for such payment, then, unless and until claim therefor shall have been made by a duly appointed guardian or other legal representative of such person, the Company may provide for such payment or any part thereof to be made to any other person or institution then contributing toward or providing for the care and maintenance of such person. Any such payment shall be a payment for the account of such person and a complete discharge of any liability of the Company and the Plan therefor.

8.11 Corporate Successors. The Plan shall be continued, following a transfer or sale of assets of the Company, or following the merger or consolidation of the Company into or with any other corporation or entity, by the transferee, purchaser or successor entity, unless the Plan

has been terminated by the Company pursuant to the provisions of Article VII prior to the effective date of such transaction.

8.12 Unclaimed Benefit. Each Participant, Surviving Spouse or beneficiary shall keep the Company informed of his current address. The Company shall not be obligated to search for the whereabouts of any person. If the location of a Participant is not made known to the Company within three years after the date on which payment of the Participant’s benefits under the Plan may first be made, payment may be made as though the Participant had died at the end of the three-year period. If, within one additional year after such three-year period has elapsed, or within three years after the actual death of a Participant, the Company is unable to locate any Surviving Spouse or beneficiary of the Participant, then the Company shall have no further obligation to pay any benefit hereunder to such Participant, Surviving Spouse or beneficiary or any other person and such benefit shall be irrevocably forfeited.

8.13 Limitations on Liability. Notwithstanding any of the preceding provisions of the Plan, none of the Company, any Affiliated Company, any member of the Committee, nor any individual acting as an employee or agent of the Company, any Affiliated Company or the Committee, shall be liable to any Participant, former Participant, Surviving Spouse or any other beneficiary or other person for any claim, loss, liability or expense incurred by such Participant, Surviving Spouse or other beneficiary or other person in connection with the Plan.

8.14 Tax Savings. Not withstanding anything to the contrary contained in the Plan, (a) if the Internal Revenue Service prevails in a claim by it that amounts credited to a Participant’s Accounts, and/or earnings thereon, constitute taxable income to the Participant or his beneficiary for any taxable year of his prior to the taxable year in which such credits and/or earnings are distributed to him or (b) legal counsel satisfactory to the Company and the applicable Participant or his beneficiary renders an opinion that the Internal Revenue Service would likely prevail in such a claim, (i) the balance of such Participant’s Accounts that are part of his Pre-2005 Benefit, to the extent constituting taxable income, and (ii) the balance of such Participants Accounts that are part of his Post-2004 Benefit, to the extent constituting taxable income pursuant to Code Section 409A and guidance and regulations thereunder, shall be immediately distributed to the Participant or his beneficiary. For purposes of this paragraph, the Internal Revenue Service shall be deemed to have prevailed in a claim if such claim is upheld by. a court of final jurisdiction, or if the Company, or a Participant or beneficiary, based upon an opinion of legal counsel satisfactory to the Company and the Participant or his beneficiary, fails to appeal a decision of the Internal Revenue Service, or a court of applicable jurisdiction, with respect to such claim, to an appropriate Internal Revenue Service appeals authority or to a court of higher jurisdiction, within the appropriate time period.

IN WITNESS WHEREOF, this Plan has been executed this 9th day of June, 2006.

	AAR CORP.

	By	/s/ Timothy O. Skelly
		Timothy O. Skelly, Vice President


ATTEST:

/s/ Howard A. Pulsifer
Howard A. Pulsifer, Secretary

APPENDIX
Additional Supplemental Company Contributions

Effective June 1, 2006, the Company shall provide for Additional Supplemental Company Contributions under Section 4.5 of the following percentages of base salary and bonus :

Participant Type	Contribution
Chief Executive Officer	22	%

Other Executive Officers designated from time to time by the Compensation Committee	10	%

Key Employees designated from time to time by the Compensation Committee	5	%

Additional Supplemental Company Contributions made pursuant to this Appendix shall be made prior to the end of each applicable Plan Year based on base salary and bonus [payable/earned] during such Plan Year. For Plan Year 2006, base salary and bonus for the entire Plan Year shall be used notwithstanding the June 1, 2006 effective date of this Appendix.

Condition to Allocation

Each Participant eligible for an Additional Supplemental Company Contribution hereunder shall receive an allocation of such Contribution to his Additional Supplemental Company Account with respect to a Plan Year if, and only if such Participant is a regular full-time Employee on the day immediately preceding the date the Contribution is made [unless the Participant terminated employment during the Plan Year due to disability or death].

Vesting

An applicable Participant shall fully vest in the balance of his Additional Supplemental Company Account upon the earlier of the Participant attaining (1) age 57 with 15 Years of Service and (2) age 65.

Forfeitures

Subject to Section 5.4, any unvested Additional Supplemental Company Contributions shall be forfeited upon the Participant’s termination of employment with the Company and its Affiliated Companies. Notwithstanding any other provisions of the Plan, (1) if the employment of the Participant with the Company and all Affiliated Companies terminates due to Cause, or (2) if the Participant during his employment with the Company and all Affiliated Companies or at any time during the one-year period after the termination of such employment for any reason (except

in the case of termination of employment for any reason on or after attaining age 60), violates the covenant not to compete with the Company and its Affiliated Companies set forth in Section 5.3, all rights of the Participant and his Surviving Spouse to vested and unvested portions of his Additional Supplemental Company Account shall be forfeited. Any amounts forfeited pursuant to this paragraph shall be retained by the Company free of any and all claims of the Participant, his Surviving Spouse or any other person claiming with respect to the Participant or his Surviving Spouse.

EX-31.1 3 a06-20640_1ex31d1.htm EX-31

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 August 31, 2006;

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: October 5, 2006

	/s/ DAVID P. STORCH
	David P. Storch
	Chairman, President and Chief Executive Officer

EX-31.2 4 a06-20640_1ex31d2.htm EX-31

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 August 31, 2006;

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: October 5, 2006

	/s/ TIMOTHY J. ROMENESKO
	Timothy J. Romenesko
	Vice President and Chief Financial Officer

EX-32.1 5 a06-20640_1ex32d1.htm EX-32

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 August 31, 2006 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: October 5, 2006

	/s/ DAVID P. STORCH
	David P. Storch
	Chairman, President and Chief Executive Officer

EX-32.2 6 a06-20640_1ex32d2.htm EX-32

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 August 31, 2006 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: October 5, 2006

	/s/ TIMOTHY J. ROMENESKO
	Timothy J. Romenesko
	Vice President and Chief Financial Officer

FORM 10-Q

For the Quarterly Period Ended August 31, 2006

AAR CORP. SUPPLEMENTAL KEY EMPLOYEE RETIREMENT PLAN

As Amended and Restated Effective January 1, 2005

AAR CORP. SUPPLEMENTAL KEY EMPLOYEE RETIREMENT PLAN As Amended and Restated Effective January 1, 2005

Condition to Allocation

Vesting

Forfeitures

AAR CORP.
SUPPLEMENTAL KEY EMPLOYEE RETIREMENT PLAN

AAR CORP.
SUPPLEMENTAL KEY EMPLOYEE RETIREMENT PLAN

As Amended and Restated Effective January 1, 2005