UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended November 30, 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 xNo 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 oNo x

As of December 31, 2006, there were 36,976,403 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 November 30, 2006

Table of Contents

			Page
Part I—FINANCIAL INFORMATION
Item 1.		Financial Statements
		Condensed Consolidated Balance Sheets	3-4
		Condensed Consolidated Statements of Operations	5
		Condensed Consolidated Statements of Cash Flows	6
		Condensed Consolidated Statements of Comprehensive Income	7
		Notes to Condensed Consolidated Financial Statements	8-17
Item 2.		Management’s Discussion and Analysis of Financial
		Condition and Results of Operations	18-26
Item 3.		Quantitative and Qualitative Disclosures About Market Risk	27
Item 4		Controls and Procedures	27

Part II—OTHER INFORMATION
Item 1A.	Risk Factors		28
Item 4.	Submission of Matters to a Vote of Security Holders		28-29
Item 6.	Exhibits		29

Signature Page			30
Exhibit Index			31

PART I — FINANCIAL INFORMATION

Item 1 — Financial Statements

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of November 30, 2006 and May 31, 2006

(In thousands)

	November 30,		May 31,
	2006		2006
	(Unaudited)
Assets:
Current assets:
Cash and cash equivalents	$	117,192	$	121,738
Accounts receivable, less allowances of $6,047 and $6,466, respectively	148,885		136,272
Inventories	262,000		259,570
Equipment on or available for short-term lease	85,979		64,022
Deposits, prepaids and other	11,512		12,986
Deferred tax assets	29,489		29,866
Total current assets	655,057		624,454

Property, plant and equipment, net of accumulated depreciation of $137,479 and $129,896, respectively	78,910		72,637

Other assets:
Goodwill	44,453		44,432
Equipment on long-term lease	126,421		140,743
Investment in joint ventures	27,773		28,498
Other	68,417		68,055
	267,064		281,728
	$	1,001,031	$	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 November 30, 2006 and May 31, 2006

(In thousands)

	November 30,			May 31,
	2006			2006
	(Unaudited)
Liabilities and stockholders’ equity:
Current liabilities:
Short-term debt	$	—		$	161
Current maturities of long-term debt	200			200
Current maturities of non-recourse long-term debt	30,419			1,928
Accounts payable	95,090			97,002
Accrued liabilities	81,119			88,497
Total current liabilities	206,828			187,788

Long-term debt, less current maturities	289,154			293,263
Non-recourse debt	—			25,313
Deferred tax liabilities	35,430			25,357
Other liabilities and deferred income	18,368			24,381
	342,952			368,314

Stockholders’ equity:
Preferred stock, $1.00 par value, authorized 250 shares; none issued	—			—
Common stock, $1.00 par value, authorized 100,000 shares; issued 41,186 and 40,789 shares, respectively	41,186			40,789
Capital surplus	273,330			274,211
Retained earnings	222,944			197,392
Treasury stock, 4,273 and 4,135 shares at cost, respectively	(72,977		)	(69,664		)
Unearned restricted stock awards	—			(6,169		)
Accumulated other comprehensive loss—
Cumulative translation adjustments	(129		)	(739		)
Minimum pension liability	(13,103		)	(13,103		)
	451,251			422,717
	$	1,001,031		$	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 and Six Months Ended November 30, 2006 and 2005
(Unaudited)
(In thousands, except per share data)

	Three Months Ended						Six Months Ended
	November 30,						November 30,
	2006			2005			2006			2005
Sales:
Sales from products	$	205,476		$	179,817		$	402,859		$	345,379
Sales from services	33,822			32,371			71,634			62,111
Sales from leasing	6,769			6,042			13,772			10,328
	246,067			218,230			488,265			417,818
Costs and operating expenses:
Cost of products	167,424			149,206			329,822			288,109
Cost of services	28,716			26,770			61,155			49,319
Cost of leasing	4,068			4,264			8,685			7,718
Cost of sales-impairment charges	—			—			7,652			—
Selling, general and administrative and other	26,198			23,621			52,179			47,522
	226,406			203,861			459,493			392,668
Gain on sale of product line	—			—			5,358			—
Earnings from aircraft joint ventures	3,761			593			6,802			798
Operating income	23,422			14,962			40,932			25,948
Gain on extinguishment of debt	—			—			2,927			—
Interest expense	(4,737		)	(4,507		)	(9,403		)	(8,629		)
Interest income	1,300			503			2,639			962
Income before provision for income taxes	19,985			10,958			37,095			18,281
Provision for income taxes	6,217			3,082			11,381			5,147
Income from continuing operations	13,768			7,876			25,714			13,134
Discontinued operations:
Operating loss, net of tax	—			—			(162		)	—
Net income	$	13,768		$	7,876		$	25,552		$	13,134
Earnings per share-basic:
Earnings from continuing operations	$	0.38		$	0.24		$	0.71		$	0.40
Loss from discontinued operations	—			—			—			—
Earnings per share - basic	$	0.38		$	0.24		$	0.71		$	0.40
Earnings per share-diluted:
Earnings from continuing operations	$	0.33		$	0.22		$	0.62		$	0.37
Loss from discontinued operations	—			—			—			—
Earnings per share - diluted	$	0.33		$	0.22		$	0.62		$	0.37
Weighted average common shares outstanding - basic	36,250			33,048			36,161			33,005
Weighted average common shares outstanding - diluted	43,145			37,137			42,969			37,073

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 Six Months Ended November 30, 2006 and 2005
(Unaudited)
(In thousands, except per share data)

	Six Months Ended
	November 30,
	2006			2005
Cash flows from operating activities:
Net income	$	25,552		$	13,134
Adjustments to reconcile net income to net cash provided from (used in) operating activities:
Depreciation and amortization	16,160			13,916
Deferred tax provision	10,450			6,180
Gain on sale of product line	(5,358		)	—
Impairment charges	7,652			—
Gain on extinguishment of debt	(2,927		)	—
Earnings from aircraft joint ventures	(6,802		)	—
Changes in certain assets and liabilities:
Accounts and trade notes receivable	(5,417		)	5,081
Inventories	3,552			(30,013		)
Equipment on or available for short-term lease	(3,061		)	(2,197		)
Equipment on long-term lease	(13,495		)	(58,445		)
Accounts payable	(1,780		)	20,960
Accrued liabilities and taxes on income	(10,067		)	1,495
Other liabilities	(4,993		)	10,383
Other	(5,061		)	(3,810		)
Net cash provided from (used in) operating activities	4,405			(23,316		)
Cash flows from investing activities:
Property, plant and equipment expenditures	(13,987		)	(8,806		)
Proceeds from disposal of assets	1			14
Proceeds from sale of product line	6,567			—
Investment in aircraft joint ventures	(4,934		)	(8,455		)
Investment in leveraged leases	342			360
Other	(729		)	161
Net cash used in investing activities	(12,740		)	(16,726		)
Cash flows from financing activities:
Proceeds from borrowings	8,916			27,303
Reduction in borrowings	(7,080		)	(16,007		)
Financing costs	(860		)	(133		)
Other, primarily stock option exercises	2,937			1,650
Net cash provided from financing activities	3,913			12,813
Effect of exchange rate changes on cash	(124		)	(28		)
Decrease in cash and cash equivalents	(4,546		)	(27,257		)
Cash and cash equivalents, beginning of period	121,738			50,338
Cash and cash equivalents, end of period	$	117,192		$	23,081

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 and Six Months Ended November 30, 2006 and 2005
(Unaudited)
(In thousands)

	Three Months Ended					Six Months Ended
	November 30,					November 30,
	2006		2005			2006		2005
Net income	$	13,768	$	7,876		$	25,552	$	13,134

Other comprehensive income (loss) -
Foreign currency translation	724		(1,048		)	610		(1,519		)
Total comprehensive income	$	14,492	$	6,828		$	26,162	$	11,615

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
November 30, 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 November 30, 2006, and the condensed consolidated results of operations, cash flows and comprehensive income for the three- and six-month periods ended November 30, 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 stock option grants made after May 31, 2006 and for the unvested portion of outstanding stock options that were granted prior to the adoption of SFAS No. 123(R). We measure compensation cost based on the fair value of the award and recognize the expense on a straight-line basis over the vesting period. In accordance with the modified prospective method of transition, the financial statements for prior periods have not been restated. See Note 2 of Notes to Condensed Consolidated Financial Statements for further discussion of the adoption of SFAS 123(R) and the impact on the first six months of fiscal year 2007 ending November 30, 2006.

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. Since its inception, a total of 4,635 shares have been granted under the Stock Benefit Plan and as of November 30, 2006, awards representing 3,140 shares were available for future grant under the Stock Benefit Plan.

Effective June 1, 2006, we adopted SFAS No. 123(R), using the modified prospective method. 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 measured based on the fair value of the award and recognized on a straight line basis over the vesting period.

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

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

On June 1, 2006, we granted stock options representing 100 shares to a select group of key leadership track employees. No executive officers were included in the group that received stock option grants. No stock options were granted during the six-month period ended November 30, 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 six-month periods ended November 30, 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:

	Six Months Ended
	November 30,
	2006		2005
Risk-free interest rate	5.0	%	3.8	%
Expected volatility of common stock	58.7	%	38.4	%
Dividend yield	0.0	%	0.0	%
Expected option term in years	4.0		1.0

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

The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123 to our stock option plan for the three- and six-month periods ended November 30, 2005:

		Three Months			Six Months
		Ended			Ended
		November 30, 2005			November 30, 2005
Net income as reported		$	7,876		$	13,134

Add: Stock-based compensation expense included in net income as reported, net of tax		407			840
Deduct: Total stock-based compensation expense determined under fair value method for all awards, net of tax		(1,384		)	(2,755		)
Pro forma net income		$	6,899		$	11,219

Earnings per share — basic:	As reported	$	0.24		$	0.40
	Pro forma	$	0.21		$	0.34
Earnings per share — diluted:	As reported	$	0.22		$	0.37
	Pro forma	$	0.19		$	0.32

The adoption of SFAS No. 123(R) on June 1, 2006 reduced our income from continuing operations for the three- and six-month periods ended November 30, 2006 by $60 and $120, respectively, and had no impact on basic and diluted earnings per share.

The following table summarizes stock option activity for the six-month period ended November 30, 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	(363	)	$	11.10
Cancelled	(29	)	$	17.39
Outstanding at November 30, 2006	2,788		$	17.84	3.9	$	24,402
Exercisable at November 30, 2006	2,691		$	17.61	3.7	$	24,158

The total fair value of stock options that vested during the six-month periods ended November 30, 2006 and 2005 was $0 and $1,628, respectively. The total intrinsic value of stock options exercised during the three-month periods ended November 30, 2006 and 2005 was $2,341 and $720, respectively. During the six-month periods ended November 30, 2006 and 2005, the total intrinsic value of stock options exercised was $3,089 and $968, respectively. The tax benefit realized from stock options exercised during the six-month periods ended November 30, 2006 and 2005 was $0. As of November 30, 2006, we had $1,073 of unearned compensation related to stock options that will be amortized over an average period of five years.

The fair value of restricted shares is the market value of our common stock on the date of grant. Amortization expense related to restricted shares during the three-month periods ended November 30, 2006 and 2005 was $925 and $626, respectively. Amortization expense related to restricted shares during the six-month periods ended November 30, 2006 and 2005 was $1,612 and $1,293, respectively.

Restricted share activity during the six-month period ended November 30, 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	(195	)	$	14.20
Forfeited	(3	)	$	15.88
Nonvested at November 30, 2006	608		$	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 November 30, 2006 we had $5,298 of unearned compensation related to restricted shares that will be amortized to expense over a weighted average period of 2.2 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 — Inventory

The summary of inventories is as follows:

	November 30,		May 31,
	2006		2006
Raw materials and parts	$	49,276	$	58,421
Work-in-process	33,688		30,651
Purchased aircraft, parts, engines and components held for sale	179,036		170,498
	$	262,000	$	259,570

Note 5 — Supplemental Cash Flow Information

	Six Months Ended
	November 30,
	2006		2005
Interest paid	$	6,923	$	6,669
Income taxes paid	1,685		235
Income tax refunds received	803		1,137

Note 6 — 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 November 30, 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 penalties or fees resulted from the termination of these arrangements.

Note 7 — 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- and six-month periods ended November 30, 2006 and 2005.

	Three Months Ended				Six Months Ended
	November 30,				November 30,
	2006		2005		2006			2005
Income from continuing operations	$	13,768	$	7,876	$	25,714		$	13,134
Loss from discontinued operations, net of tax	—		—		(162		)	—
Net income	$	13,768	$	7,876	$	25,552		$	13,134

Basic shares:
Weighted average common shares outstanding	36,250		33,048		36,161			33,005

Earnings per share — basic:
Earnings from continuing operations	$	0.38	$	0.24	$	0.71		$	0.40
Loss from discontinued operations	—		—		—			—
Earnings per share - basic	$	0.38	$	0.24	$	0.71		$	0.40

Net income	$	13,768	$	7,876	$	25,552		$	13,134
Add: After-tax interest on convertible debt	491		306		983			612
Net income for diluted EPS calculation	$	14,259	$	8,182	$	26,535		$	13,746

Diluted shares:
Weighted average common shares outstanding	36,250		33,048		36,161			33,005
Additional shares from the assumed exercise of stock options	523		485		449			464
Additional shares from the assumed vesting of restricted stock	395		—		382			—
Additional shares from the assumed conversion of convertible debt	5,977		3,604		5,977			3,604
Weighted average common shares outstanding — diluted	43,145		37,137		42,969			37,073

Earnings per share — diluted:
Earnings from continuing operations	$	0.33	$	0.22	$	0.62		$	0.37
Loss from discontinued operations	—		—		—			—
Earnings per share - diluted	$	0.33	$	0.22	$	0.62		$	0.37

At November 30, 2006 and 2005, respectively, stock options to purchase 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 8 —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 six-month periods ended November 30, 2006 and 2005, we were paid $438 and $274, 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				Six Months Ended
	November 30,				November 30,
	2006		2005		2006		2005
Statement of operations information:
Sales	$	6,593	$	10,846	$	38,368	$	20,426
Income before provision for income taxes	1,998		1,330		8,211		1,870

	November 30,		May 31,
	2006		2006
Balance sheet information:
Assets	$	161,609	$	123,177
Debt	104,301		64,934
Members’ capital	53,379		54,949

During the three-month period ended November 30, 2006, we sold our interest in two aircraft owned by an aircraft joint venture. The pre-tax gain on that sale was $2,853 and is recorded in earnings from aircraft joint ventures on the Condensed Consolidated Statements of Operations.

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 November 30, 2006.

Note 9 — Gain on Sale of Product Line

During the first quarter of fiscal 2007, we sold substantially all assets, subject to certain liabilities, of a product line within our Structures and Systems segment. In conjunction with the asset purchase and sale agreement, we entered into a transition services agreement with the buyer whereby we will continue to support the product line, and provide other administrative and operational services as defined, until such time as the purchaser has commenced manufacturing at its facility. Proceeds from the sale were $6,567 and the net carrying value of the assets sold was $1,209, resulting in a gain on sale of product line

of $5,358. The gain on this transaction has been classified as a component of operating income in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.

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 is as follows:

	November 30,		May 31,		November 30,
	2006		2006		2001
Net impaired inventory and engines	$	28,400	$	36,000	$	89,600

Proceeds from sales of impaired inventory and engines for the six-month period ended November 30, 2006 and the twelve-month period ended May 31, 2006 were $2,000 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				Six Months Ended
	November 30,				November 30,
	2006		2005		2006		2005
Sales:
Aviation Supply Chain	$	133,904	$	107,993	$	261,420	$	215,104
Maintenance, Repair and Overhaul	44,477		43,257		94,072		81,229
Structures and Systems	64,268		63,817		124,631		115,177
Aircraft Sales and Leasing	3,418		3,163		8,142		6,308
	$	246,067	$	218,230	$	488,265	$	417,818

	Three Months Ended				Six Months Ended
	November 30,				November 30,
	2006		2005		2006			2005
Gross profit (loss):
Aviation Supply Chain	$	29,896	$	22,576	$	52,151		$	42,286
Maintenance, Repair and Overhaul	6,147		4,963		13,304			10,705
Structures and Systems	8,847		9,828		15,918			18,165
Aircraft Sales and Leasing	969		623		(422		)	1,516
	$	45,859	$	37,990	$	80,951		$	72,672

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

AAR CORP. and Subsidiaries

November 30, 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.

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.

The table below sets forth consolidated sales for our four business segments for the three- and six-month periods ended November 30, 2006 and 2005.

	Three Months Ended				Six Months Ended
	November 30,				November 30,
	2006		2005		2006		2005
Sales:
Aviation Supply Chain	$	133,904	$	107,993	$	261,420	$	215,104
Maintenance, Repair and Overhaul	44,477		43,257		94,072		81,229
Structures and Systems	64,268		63,817		124,631		115,177
Aircraft Sales and Leasing	3,418		3,163		8,142		6,308
	$	246,067	$	218,230	$	488,265	$	417,818

During calendar year 2006, many of the domestic commercial airlines reported improved financial results reflecting their ability to implement fare increases to partially offset the relative continued high cost of fuel. The improvement has also been driven by the airlines’ continued focus on controlling non-fuel related expenses and the implementation of operational efficiencies. We expect certain carriers will continue to aggressively seek ways to reduce their cost structure; including outsourcing more of their maintenance and support functions to third parties. Further, low-cost carriers continue to expand their presence around the world. Many of these low-cost carriers are flying newer aircraft which will result in increasing demand for maintenance and parts support in future years. We believe we remain well positioned to respond to the market with our broad range of products and services as these trends continue to develop.

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

AAR CORP. and Subsidiaries

November 30, 2006

(In thousands)

Results of Operations

Three-Month Period Ended November 30, 2006

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

Consolidated sales for the second quarter ended November 30, 2006 increased $27,837 or 12.8% over the second quarter of last year, primarily due to increased sales to commercial and defense customers in our Aviation Supply Chain segment. Sales in the Aviation Supply Chain segment increased $25,911 or 24.0% 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, the implementation of new supply chain programs and the improved commercial airline environment. 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 $7,320 or 32.4% over the prior year primarily due to increased sales volume. The gross profit margin percentage increased to 22.3% from 20.9% in the prior year due to effective purchasing and favorable mix of products sold.

In the Maintenance, Repair and Overhaul segment, sales increased $1,220 or 2.8% from the same quarter last year. The increase in sales is primarily attributable to increased demand for our landing gear overhaul services, partially offset by lower sales at our Indianapolis maintenance facility due principally to fewer scheduled maintenance visits from a major airline customer. Gross profit in the Maintenance, Repair and Overhaul segment increased $1,184 or 23.9% over the prior year as our landing gear and Oklahoma City airframe maintenance businesses improved their gross profit during the quarter, reflecting increased sales for these services and operational efficiencies.

In the Structures and Systems segment, sales remained relatively flat increasing $451 or 0.7% over the prior year. Sales increased at our Mobility Systems business as demand for mobility products remained strong. Sales of cargo systems declined compared to the prior year as we began relocating production to a new manufacturing facility in North Carolina. Gross profit in the Structures and Systems segment declined $981 or 10.0% compared to the prior year as the gross profit margin percentage decreased from 15.4% to 13.8% due to the unfavorable mix of products sold.

In the Aircraft Sales and Leasing segment, sales increased $255 or 8.1% compared with the prior year. Our strategy is to build an aircraft portfolio through participation in joint ventures and for our own account. During the second quarter, we sold our interest in two aircraft and acquired two aircraft through a joint venture keeping the total number of aircraft held in joint ventures at 17 (see Note 8 of Notes to Condensed Consolidated Financial Statements). The increase in earnings from aircraft joint ventures compared to the prior year is primarily due to the sale of our interest in the two aircraft. We also own eight aircraft outside of the joint ventures. Of the eight aircraft owned by us outside the aircraft joint ventures, five were acquired prior to September 11, 2001. Current lease rates for many commercial aircraft are less than pre-September 11 levels. Gross profit in the Aircraft Sales and Leasing segment increased $346 compared to the prior year.

Operating income increased $8,460 or 56.5% compared with the prior year’s quarter due to increased sales and earnings from aircraft joint ventures partially offset by an increase in selling, general and administrative expenses. During the second quarter, our selling, general and administrative expenses increased $2,577 or 10.9% 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 10.6% compared to 10.8% in the prior year. Net interest expense decreased $567 or 14.2% primarily due to an increase in interest income on higher average invested cash during the period. Our effective income tax rate

increased to 31.1% compared with 28.1% in the prior year due to lower anticipated tax benefits on export activities.

Income from continuing operations was $13,768 for the second quarter of fiscal 2007 compared to $7,876 in the prior year due to the factors discussed above.

Six-Month Period Ended November 30, 2006

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

Consolidated sales for the six-months ended November 30, 2006 increased $70,447 or 16.9% over the same period last year. Each reporting segment experienced sales growth with sales to commercial customers increasing 19.4% and sales to defense customers up 12.7% compared to the prior year. The sales increase to commercial airline customers reflects the improved commercial airline environment, our expanded presence in global markets, growth in supply chain programs, and increased demand for airframe maintenance and landing gear repair overhaul services. Sales to defense customers increased as we continue to experience strong demand for performance-based logistics programs and specialized mobility products.

Sales in the Aviation Supply Chain segment increased $46,316 or 21.5% over the prior year. The sales increase reflects strong demand for engine and airframe parts from commercial customers due to improved sourcing and program execution as well as the implementation of new supply chain programs. The increase in sales to defense customers was driven by continued strong demand for parts support from performance-based logistics programs. Gross profit in the Aviation Supply Chain segment increased $9,865 or 23.3% over the prior year primarily due to increased sales volume, partially offset by an impairment charge of $4,750 recorded in this segment during the first quarter of fiscal 2007 (see Note 10 of Notes to Condensed Consolidated Financial Statements). The gross profit margin percentage increased slightly to 19.9% from 19.7% in the prior year due to effective purchasing and favorable mix of products sold, offset by the aforementioned impairment charge.

In the Maintenance, Repair and Overhaul segment, sales increased $12,843 or 15.8% over the prior year. The increase in sales is primarily attributable to increased demand for landing gear overhaul services as well as airframe maintenance at our Oklahoma and Indianapolis airframe maintenance facilities. Gross profit in the Maintenance, Repair and Overhaul segment increased $2,599 or 24.3% over the prior year and the gross profit margin percentage increased to 14.1% from 13.2% as our landing gear and Oklahoma City businesses improved their gross profit, reflecting robust demand for these services and increased operational efficiencies, partially offset by lower margins at our Indianapolis-based maintenance facility reflecting lower labor utilization.

In the Structures and Systems segment, sales increased $9,454 or 8.2% over the prior year. The increase in sales was primarily due to increased deliveries of mobility products to the U.S. Department of Defense. Sales of our cargo systems were lower as we began relocating production to a new manufacturing facility in North Carolina. Gross profit in the Structures and Systems segment declined $2,247 or 12.4% compared to the prior year as the gross profit margin percentage decreased from 15.8% to 12.8% due to the unfavorable mix of products sold.

In the Aircraft Sales and Leasing segment, sales increased $1,834 or 29.1% compared with the prior year. Our strategy in the Aircraft Sales and Leasing segment is to build an aircraft portfolio through participation in joint ventures and for our own account. During the first six months of fiscal 2007, our joint ventures purchased six aircraft and sold five bringing the total number of aircraft held in joint ventures to 17 (see Note 8 of Notes to Condensed Consolidated Financial Statements). The increase in earnings from aircraft joint ventures compared to the prior year is primarily due to the sale of these five

aircraft. We also own eight aircraft outside of the joint ventures. 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 $1,938 compared to the prior year principally due to the impairment charge of $2,902 recorded during the first quarter of fiscal 2007 (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 $14,984 or 57.7% compared with the prior year’s period due to increased sales, earnings from aircraft joint ventures and gain on sale of product line partially offset by impairment charges and an increase in selling, general and administrative expenses. During the first six months of fiscal 2007, our selling, general and administrative expenses increased $4,657 or 9.8% 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 11.4% in the prior year. Net interest expense decreased $903 or 11.8% primarily due to an increase in interest income on higher average invested cash during the period. Our effective income tax rate increased to 30.7% compared with 28.2% in the prior year due to lower anticipated tax benefits on export activities.

Income from continuing operations was $25,714 compared to $13,134 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 November 30, 2006, our liquidity and capital resources included cash of $117,192 and working capital of $448,229. On August 31, 2006, we entered into a credit agreement with various financial institutions, as lenders, and LaSalle Bank National Association, as administrative agent for the lenders (the “LaSalle Credit Agreement”). The LaSalle Credit Agreement created a $140,000 unsecured revolving credit facility that we can draw upon for general corporate purposes. Under certain circumstances, we may request an increase to the revolving commitment by an aggregate amount of up to $35,000, not to exceed $175,000 in total. The LaSalle Credit Agreement expires on August 31, 2010. Borrowings under the LaSalle Credit Agreement bear interest at the London Interbank Offered Rate (“LIBOR”) plus 125 to 200 basis points based on certain financial measurements. There were no borrowings outstanding under this facility at November 30, 2006. On August 31, 2006, we terminated our secured revolving credit agreement with Merrill Lynch Capital and during the second quarter of fiscal 2007, we terminated our accounts receivable securitization program. No borrowings were outstanding and no accounts receivable were sold at the date of these terminations. In addition, no material penalties or fees resulted from the terminations. We also have $2,961 available under a foreign line of credit and there were no borrowings outstanding under this facility at November 30, 2006.

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 six-month period ended November 30, 2006, we generated $4,405 of cash from operations primarily due to net income and depreciation and amortization of $41,712, partially offset by a reduction in accrued and other liabilities of $15,060 principally reflecting a payment for equipment acquired during fiscal 2006 to support a supply chain program, as well as incentive compensation payments. Also during the six-month period ended November 30, 2006, there was a use of cash from operations for equipment on both short- and long-term lease of $16,556, principally reflecting the acquisition of several engines for placement on lease.

During the six-month period ended November 30, 2006, our investing activities used $12,740 of cash, principally as a result of capital expenditures of $13,987 and cash invested in aircraft for joint ventures of $4,934, partially offset by proceeds from the sale of a product line of $6,567.

During the six-month period ended November 30, 2006, cash provided from financing activities was $3,913, comprised principally of proceeds from borrowings of $8,916 and proceeds from stock option exercises of $2,937, partially offset by a reduction in borrowings of $7,080 which includes $4,009 for the early retirement of 6.875% Notes due December 15, 2007.

Contractual Obligations and Off-Balance Sheet Arrangements

A summary of contractual obligations and off-balance sheet arrangements as of November 30, 2006 is as follows:

	Payments Due by Period
													After
	Total		11/30/07		11/30/08		11/30/09		11/30/10		11/30/11		11/30/11
On Balance Sheet:
Debt	$	289,354	$	200	$	56,391	$	200	$	208	$	55,000	$	177,355
Non-recourse Debt	30,419		30,419		-		-		-		-		-
Interest	96,160		14,124		10,519		8,681		8,681		8,056		46,099

Off Balance Sheet:
Garden City Operating Lease	29,809		1,437		1,473		1,510		1,548		1,587		22,254

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

In July 2006, the FASB issued Interpretation No. 48 (FIN No. 48), “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.” FIN No. 48 clarifies the recognition threshold and measurement requirements for tax positions taken or expected to be taken in tax returns and provides guidance on the related classification and disclosure. The provisions of FIN No. 48 are effective for fiscal years beginning after December 15, 2006. Accordingly, we will adopt FIN No. 48 no later than the beginning of fiscal year 2008. We 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 as set forth in our Annual Report on Form 10-K for the year ended May 31, 2006.

Item 4 — Controls and Procedures

As required by Rules 13a-15(e) and 15d-15(e) of the Exchange Act, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of November 30, 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 November 30, 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 second quarter ended November 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1A — Risk Factors

There have been no material changes to our risk factors as set forth in our Annual Report on Form 10-K for the year ended May 31, 2006, 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. We have developed a comprehensive transition plan which addresses all requirements of the move. We expect third quarter fiscal 2007 operating results, and possibly fourth quarter fiscal 2007 operating results, to be negatively impacted by the relocation of our cargo handling systems manufacturing business to North Carolina.

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

Our Annual Meeting of Stockholders was held on October 18, 2006. The following items were acted upon at the meeting.

1) Election of three Class I directors to serve until the 2009 Annual Meeting of Stockholders. Three directors were nominated and elected by the stockholders by the requisite vote.

Directors Nominated and Elected at the Meeting

	Votes	Votes
	For	Withheld
Michael R. Boyce	33,740,468	265,739
James G. Brocksmith, Jr.	32,649,385	1,356,822
David P. Storch	33,179,832	826,375

Continuing Directors
Gerald F. Fitzgerald, Jr.
Ronald R. Fogleman
James E. Goodwin
Patrick J. Kelly
Marc J. Walfish
Ronald B. Woodard

2) Ratification of the appointment of KPMG LLP as the independent registered public accounting firm for the fiscal year ending May 31, 2007.

		Votes For		33,792,271
		Votes Against		197,292
		Abstained		16,664

3) Approval of the performance goals under the AAR CORP. Section 162(m) Incentive Goal Program.

	Votes For	32,466,443
	Votes Against	1,466,906
	Abstained	72,857

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:	January 8, 2007	/s/ TIMOTHY J. ROMENESKO
		Timothy J. Romenesko
		Vice President and Chief Financial Officer
		(Principal Financial Officer and officer duly
		authorized to sign on behalf of registrant)


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

EXHIBIT INDEX

Exhibit No.	Description		Exhibits
31.	Rule 13a-14(a)/15(d)-14(a) Certifications	31.1	Section 302 Certification dated January 8, 2007 of David P. Storch, Chairman, President and Chief Executive Officer of Registrant (filed herewith).

		31.2	Section 302 Certification dated January 8, 2007 of Timothy J. Romenesko, Vice President and Chief Financial Officer of Registrant (filed herewith).

32.	Section 1350 Certifications	32.1	Section 906 Certification dated January 8, 2007 of David P. Storch, Chairman, President and Chief Executive Officer of Registrant (filed herewith).

		32.2	Section 906 Certification dated January 8, 2007 of Timothy J. Romenesko, Vice President and Chief Financial Officer of Registrant (filed herewith).