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 February 28, 2010
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period fromto

Commission File No. 1-6263

AAR CORP.

(Exact name of registrant as specified in its charter)

Delaware	36-2334820
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
One AAR Place, 1100 N. Wood Dale Road Wood Dale, Illinois	60191
(Address of principal executive offices)	(Zip Code)

(630) 227-2000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x  No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes o  No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x	Accelerated filer o
Non-accelerated filer o	Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o  No x

As of February 28, 2010, there were 39,025,309 shares of the registrant’s Common Stock, $1.00 par value per share, outstanding.

AAR CORP. and Subsidiaries

Quarterly Report on Form 10-Q

For the Quarter Ended February 28, 2010

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 Changes in Equity	7
	Notes to Condensed Consolidated Financial Statements	8-22
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23-30
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	30
Part II — OTHER INFORMATION
Item 1A.	Risk Factors	31
Item 6.	Exhibits	31
Signature Page		32
Exhibit Index		33

2

PART I — FINANCIAL INFORMATION

Item 1 — Financial Statements

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of February 28, 2010 and May 31, 2009

(In thousands)

	February 28, 2010		May 31, 2009
	(Unaudited)
Assets:
Current assets:
Cash and cash equivalents	$	117,526	$	112,505
Accounts receivable, less allowances of $5,567 and $4,677, respectively	208,275		227,300
Inventories	332,384		347,495
Equipment on or available for short-term lease	112,261		129,929
Deposits, prepaids and other	14,242		15,856
Deferred tax assets	18,227		18,227
Total current assets	802,915		851,312
Property, plant and equipment, net of accumulated depreciation of $189,475 and $174,873, respectively	129,560		125,048
Other assets:
Goodwill and other intangible assets, net	147,473		150,227
Equipment on long-term lease	110,213		120,538
Investment in joint ventures	48,598		45,433
Other	85,993		83,347
	392,277		399,545
	$	1,324,752	$	1,375,905

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

3

AAR CORP. and Subsidiaries

Condensed Consolidated Balance Sheets

As of February 28, 2010 and May 31, 2009

(In thousands)

	February 28, 2010			May 31,  2009
	(Unaudited)
Liabilities and equity:
Current liabilities:
Short-term debt	$	—		$	50,005
Current maturities of long-term debt	158			200
Current maturities of non-recourse long-term debt	2,600			11,722
Current maturities of long-term capital lease obligations	1,750			1,673
Accounts payable	93,896			100,651
Accrued liabilities	79,259			90,167
Total current liabilities	177,663			254,418
Long-term debt, less current maturities	301,604			302,823
Non-recourse debt	14,767			16,728
Capital lease obligations	7,199			8,658
Deferred tax liabilities	57,534			63,593
Other liabilities and deferred income	29,410			32,951
	410,514			424,753
Equity:
Preferred stock, $1.00 par value, authorized 250 shares; none issued	—			—
Common stock, $1.00 par value, authorized 100,000 shares; issued 44,407 and 44,201 shares, respectively	44,407			44,201
Capital surplus	413,228			405,029
Retained earnings	408,087			374,659
Treasury stock, 5,382 and 5,317 shares at cost, respectively	(104,338		)	(103,159		)
Accumulated other comprehensive loss	(24,353		)	(23,996		)
Total AAR shareholders’ equity	737,031			696,734
Noncontrolling interest	(456		)	—
Total equity	736,575			696,734
	$	1,324,752		$	1,375,905

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

4

AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Operations

For the Three and Nine Months Ended February 28, 2010 and 2009

(Unaudited)

(In thousands, except per share data)

	Three Months Ended February 28,						Nine Months Ended February 28,
	2010			2009			2010			2009
Sales:
Sales from products	$	250,458		$	276,101		$	792,333		$	858,660
Sales from services	49,084			55,103			156,343			170,669
Sales from leasing	10,065			7,588			31,138			22,939
	309,607			338,792			979,814			1,052,268
Costs and operating expenses:
Cost of products	208,901			226,469			673,377			697,964
Cost of services	38,515			44,197			121,295			141,943
Cost of leasing	3,266			3,501			8,334			10,756
Cost of sales — impairment charge	—			—			—			21,033
Selling, general and administrative	35,972			36,579			110,455			111,582
	286,654			310,746			913,461			983,278
Earnings from joint ventures	56			1,401			150			7,213
Operating income	23,009			29,447			66,503			76,203
Gain on extinguishment of debt	—			889			913			11,392
Interest expense	(6,524		)	(7,543		)	(19,544		)	(24,110		)
Interest income	146			308			752			1,170
Loss on investment	(1,876		)	—			(1,876		)	—
Income from continuing operations before provision for income taxes	14,755			23,101			46,748			64,655
Provision for income taxes	4,970			5,887			14,612			20,110
Income from continuing operations	9,785			17,214			32,136			44,545
Discontinued operations, net of tax:
Operating loss	—			—			—			(546		)
Loss on disposal	—			—			—			(1,403		)
Loss from discontinued operations	—			—			—			(1,949		)
Net income attributable to AAR and noncontrolling interest	9,785			17,214			32,136			42,596
Loss attributable to noncontrolling interest	127			—			1,292			—
Net income attributable to AAR	$	9,912		$	17,214		$	33,428		$	42,596
Earnings per share — basic:
Earnings from continuing operations	$	0.26		$	0.45		$	0.88		$	1.17
Loss from discontinued operations	—			—			—			(0.05		)
Earnings per share — basic	$	0.26		$	0.45		$	0.88		$	1.12
Earnings per share — diluted:
Earnings from continuing operations	$	0.26		$	0.43		$	0.87		$	1.14
Loss from discontinued operations	—			—			—			(0.05		)
Earnings per share — diluted	$	0.26		$	0.43		$	0.87		$	1.09
Weighted average common shares outstanding — basic	38,217			38,043			38,154			38,067
Weighted average common shares outstanding — diluted	43,108			42,570			42,921			42,830

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

5

AAR CORP. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

For the Nine Months Ended February 28, 2010 and 2009

(Unaudited)

(In thousands)

	Nine Months Ended February 28,
	2010			2009
Cash flows from operating activities:
Net income attributable to AAR and noncontrolling interest	$	32,136		$	42,596
Adjustments to reconcile net income attributable to AAR and noncontrolling interest to net cash provided from (used in) operating activities:
Depreciation and amortization	26,609			30,836
Amortization of debt discount	8,699			10,357
Deferred tax provision	(5,560		)	222
Tax benefits from exercise of stock options	(223		)	(171		)
Impairment charge	—			21,033
Gain on extinguishment of debt	(913		)	(11,392		)
Loss on investment	1,876			—
Earnings from joint ventures	(150		)	(7,213		)
Loss on disposal of business, net of tax	—			1,403
Changes in certain assets and liabilities:
Accounts and trade notes receivable	22,159			(20,189		)
Inventories	15,599			(67,897		)
Equipment on or available for short-term lease	16,329			(1,843		)
Equipment on long-term lease	4,962			3,123
Accounts payable	(6,789		)	2,760
Accrued liabilities and taxes on income	(14,674		)	(14,911		)
Other liabilities	(1,313		)	(2,035		)
Other, primarily deposits and program costs	(4,100		)	5,393
Net cash provided from (used in) operating activities	94,647			(7,928		)
Cash flows from investing activities:
Property, plant and equipment expenditures	(20,749		)	(23,462		)
Proceeds from disposal of assets	84			16
Proceeds from sale of business	650			100
Proceeds from sale of available for sale securities	434			—
Proceeds from sale of product line	—			767
Proceeds from aircraft joint ventures	37			4,230
Investment in aircraft joint ventures	(4,198		)	(440		)
Proceeds from leveraged leases	5,220			(166		)
Other	(1,575		)	(1,533		)
Net cash used in investing activities	(20,097		)	(20,488		)
Cash flows from financing activities:
Proceeds from short-term borrowings, net	103			75,251
Reduction in borrowings	(70,204		)	(54,784		)
Reduction in capital lease obligations	(1,382		)	(1,109		)
Reduction in equity due to convertible bond repurchase	(254		)	(5,043		)
Stock option exercises	1,614			595
Tax benefits from exercise of stock options	223			171
Contributions from noncontrolling interest	462			—
Net cash provided from (used in) financing activities	(69,438		)	15,081
Effect of exchange rate changes on cash	(91		)	(2,314		)
Increase (decrease) in cash and cash equivalents	5,021			(15,649		)
Cash and cash equivalents, beginning of period	112,505			109,391
Cash and cash equivalents, end of period	$	117,526		$	93,742

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

6

AAR CORP. and Subsidiaries

Condensed Consolidated Statement of Changes in Equity

For the Nine Months Ended February 28, 2010

(Unaudited)

(In thousands)

	Common Stock		Treasury Stock			Capital Surplus			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total AAR Stockholders’ Equity			Noncontrolling Interest			Total Equity
Balance, May 31, 2009	$	44,201	$	(103,159	)	$	330,002		$	409,847		$	(23,996	)	$	656,895		$	—		$	656,895
Adoption of convertible debt accounting standard	—		—			75,027			(35,188		)	—			39,839			—			39,839
Balance, May 31, 2009, as adjusted	44,201		(103,159		)	405,029			374,659			(23,996		)	696,734			—			696,734
Net income (loss)	—		—			—			33,428			—			33,428			(1,292		)	32,136
Exercise of stock options and stock awards	174		(948		)	3,496			—			—			2,722			—			2,722
Tax benefit related to share- based plans	—		—			223			—			—			223			—			223
Restricted stock activity	32		—			4,503			—			—			4,535			374			4,909
Bond hedge and warrant activity	—		(231		)	231			—			—			—			—			—
Equity portion of bond repurchase	—		—			(254		)	—			—			(254		)	—			(254		)
Foreign currency translation loss	—		—			—			—			(357		)	(357		)	—			(357		)
Contributions from noncontrolling interest	—		—			—			—			—			—			462			462
Balance, February 28, 2010	$	44,407	$	(104,338	)	$	413,228		$	408,087		$	(24,353	)	$	737,031		$	(456	)	$	736,575

The accompanying Notes to Condensed Consolidated Financial

Statements are an integral part of these statements.

7

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 1 — Basis of Presentation

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

We have prepared these statements without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”).  The condensed consolidated balance sheet as of May 31, 2009 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 financial position of AAR CORP. and its subsidiaries as of February 28, 2010, the results of its operations for the three- and nine-month periods ended February 28, 2010 and 2009, and its cash flows for the nine-month periods ended February 28, 2010 and 2009.  The results of operations for such interim periods are not necessarily indicative of the results for the full year.

Effective June 1, 2009, the Company adopted a new accounting standard which establishes accounting and disclosure requirements for subsequent events.  The standard details the period after the balance sheet date during which the Company should evaluate events or transactions that occur for potential recognition or disclosure in the financial statements, the circumstances under which the Company should recognize events or transactions occurring after the balance sheet date in its financial statements and the required disclosures for such events.

On June 1, 2009, the Company adopted a new accounting standard that requires noncontrolling interests (previously referred to as a minority interest) to be treated as a separate component of equity under most circumstances and not as a liability or other item outside of equity.  The standard also changes the presentation requirements of the statement of operations and requires additional disclosures.

On June 1, 2009, we adopted a new accounting standard related to the accounting for convertible debt.  See Note 7 for further discussion.

8

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 2 — Accounting for Stock-Based Compensation

We provide stock-based awards under the AAR CORP. Stock Benefit Plan (“Stock Benefit Plan”), which has been approved by our stockholders.  Under this plan, we are authorized to issue stock options to employees and non-employee directors that allow the grant recipients to purchase shares of common stock at a price not less than the fair market value of the common stock on the date of grant.  Generally, stock options awarded expire ten years from the date of grant and are exercisable in either three or five equal annual increments commencing one year after the date of grant.  We issue common stock upon the exercise of stock options.  In addition to stock options, the Stock Benefit Plan also provides for the grant of restricted stock awards and performance based restricted stock awards, as well as for the grant of stock appreciation units; however, to date, no stock appreciation units have been granted.

We measure share-based compensation based on the fair value of the award at the grant date, and recognize the cost of share-based awards over the applicable service period, which is generally the vesting period.

During the nine-month periods ended February 28, 2010 and 2009, we granted stock options representing 687,000 shares and 184,750 shares, respectively.

The weighted average fair values of stock options granted during the nine-month periods ended February 28, 2010 and 2009 were $7.40 and $8.27, respectively.  The fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

	Nine Months Ended February 28,
	2010		2009
Risk-free interest rate	2.3	%	3.3	%
Expected volatility of common stock	49.2	%	38.9	%
Dividend yield	0.0	%	0.0	%
Expected option term in years	6.0		6.0

The following table summarizes stock option activity for the nine-month period ended February 28, 2010:

	Number of Options (in thousands)		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value
Outstanding at May 31, 2009	1,225		$	21.18
Granted	687		$	15.10
Exercised	(174	)	$	11.65
Cancelled	(155	)	$	22.76
Outstanding at February 28, 2010	1,583		$	19.19	5.9	$	8,904
Exercisable at February 28, 2010	708		$	20.75	4.8	$	3,324

9

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

The total fair value of stock options that vested during the nine-month periods ended February 28, 2010 and 2009 was $690 and $434, respectively.  The total intrinsic value of stock options exercised during the nine-month periods ended February 28, 2010 and 2009 was $1,963 and $489, respectively.  The tax benefit realized from stock options exercised during the nine-month periods ended February 28, 2010 and 2009 was $223 and $171, respectively.  Expense charged to operations for stock options during the three-month periods ended February 28, 2010 and 2009 was $619 and $196, respectively.  Expense charged to operations for stock options during the nine-month periods ended February 28, 2010 and 2009 was $1,646 and $585, respectively.  As of February 28, 2010, we had $5,856 of unearned compensation related to stock options that will be amortized to expense over an average remaining period of 2.5 years.

The fair value of restricted stock awards is the market value of our common stock on the date of grant.  Amortization expense related to restricted stock awards during the three-month periods ended February 28, 2010 and 2009 was $1,648 and $1,225, respectively.  Amortization expense related to restricted stock awards during the nine-month periods ended February 28, 2010 and 2009 was $4,624 and $3,874, respectively.

Restricted share activity during the nine-month period ended February 28, 2010 is as follows:

	Number of Shares (in thousands)		Weighted Average Fair Value on Grant Date
Nonvested at May 31, 2009	878		$	24.29
Granted	40		$	15.45
Vested	(115	)	$	29.51
Forfeited	(17	)	$	23.41
Nonvested at February 28, 2010	786		$	23.10

During the nine-month period ended February 28, 2010, we granted a total of 36,000 restricted shares to members of the Board of Directors.  As of February 28, 2010 we had $5,314 of unearned compensation related to restricted shares that will be amortized to expense over a weighted average period of 2.1 years.

Note 3 — Revenue Recognition

Sales and related cost of sales for product sales are recognized upon shipment of the product to the customer.  Our standard terms and conditions provide that title passes to the customer when the product is shipped to the customer.  Sales of certain defense products are recognized upon customer acceptance, which includes transfer of title.  Sales from services and the related cost of services are generally recognized when customer-owned material is shipped back to the customer.  We have adopted this accounting policy because at the time the customer-owned material is shipped back to the customer, all services related to that material are complete as our service agreements generally do not require us to provide services at customer sites.  Furthermore, serviced units are typically shipped to the customer immediately upon completion of the related services.  Sales and related cost of sales for certain long-term manufacturing contracts, certain large airframe maintenance contracts and certain long-term aircraft component maintenance agreements are recognized by the percentage of completion method, either based on the relationship of costs incurred to date to estimated total costs or the units of delivery method.  Lease revenues are recognized as earned.  Income from monthly or quarterly rental payments is recorded in the pertinent period according to the lease agreement.  However, for leases that provide variable rents, we recognize lease income on a straight-line basis.  In addition to a monthly lease rate, some engine leases

10

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

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:

	February 28,		May 31,
	2010		2009
Raw materials and parts	$	53,433	$	62,565
Work-in-process	54,386		52,584
Purchased aircraft, parts, engines and components held for sale	224,565		232,346
	$	332,384	$	347,495

Note 5 — Supplemental Cash Flow Information

	Nine Months Ended
	February 28,
	2010		2009
Interest paid	$	10,517	$	13,505
Income taxes paid	22,153		26,511
Income tax refunds received	441		417

Note 6 — Comprehensive Income

A summary of the components of comprehensive income (loss) is as follows:

	Three Months Ended February 28,						Nine Months Ended February 28,
	2010			2009			2010			2009
Net income attributable to AAR and noncontrolling interest	$	9,785		$	17,214		$	32,136		$	42,596
Other comprehensive income (loss) —
Cumulative translation adjustments	(1,741		)	(900		)	(357		)	(3,890		)
Unrealized gain (loss) on investment, net of tax	297			(119		)	—			(1,071		)
Total comprehensive income	$	8,341		$	16,195		$	31,779		$	37,635

11

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 7 — Financing Arrangements

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

	February 28,			May 31,
	2010			2009
Recourse debt
Notes payable due May 15, 2011 with interest at 8.39% payable semi-annually on June 1 and December 1	$	42,000		$	42,000
Mortgage loan (secured by Wood Dale, Illinois facility) due August 1, 2015 with interest at 5.01%	11,000			11,000
Convertible notes payable due March 1, 2014 with interest at 1.625% payable semi-annually on March 1 and September 1	71,270			77,106
Convertible notes payable due March 1, 2016 with interest at 2.25% payable semi-annually on March 1 and September 1	53,070			52,847
Convertible notes payable due February 1, 2026 with interest at 1.75% payable semi-annually on February 1 and August 1	99,264			94,762
Industrial revenue bonds (secured by trust indenture on property, plant and equipment) due December 1, 2010 and August 1, 2018 with floating interest rate, payable monthly	25,158			25,308
Total recourse debt	301,762			303,023
Current maturities of recourse debt	(158		)	(200		)
Long-term recourse debt	$	301,604		$	302,823
Non-recourse debt
Non-recourse note payable due June 30, 2009 with interest at 3.85%	$	—		$	9,261
Non-recourse note payable due July 19, 2012 with interest at 7.22%	12,776			14,082
Non-recourse note payable due April 3, 2015 with interest at 8.38%	4,591			5,107
Total non-recourse debt	17,367			28,450
Current maturities of non-recourse debt	(2,600		)	(11,722		)
Long-term non-recourse debt	$	14,767		$	16,728

Recourse debt

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

Holders may convert their Notes based on a conversion rate of 28.1116 shares of our common stock per $1,000 principal amount of Notes, which is equivalent to an initial conversion price of $35.57 per share, only under the following circumstances: (i) during any calendar quarter beginning after March 31, 2008 (and only during such calendar quarter) if, as of the last day of the preceding calendar quarter, the closing price of our common stock for at least 20 trading days in a period of 30 consecutive trading

12

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

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

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

The Notes are senior, unsecured obligations and rank equal in right of payment with all of our existing and future unsecured and unsubordinated indebtedness.  Costs associated with the issuance and sale of the Notes of approximately $4,366 are being amortized using the effective interest method over a six- and eight-year period.

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

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

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

On February 1, 2006, we completed the sale of $150,000 principal amount of convertible senior notes.  The notes are due on February 1, 2026 unless earlier redeemed, repurchased or converted, and bear interest at 1.75% payable semiannually on February 1 and August 1.

A holder may convert the notes into shares of common stock based on a conversion rate of 33.9789 shares per $1,000 principal amount of notes, which is equivalent to an initial conversion price of approximately $29.43 per share, under the following circumstances: (i) during any calendar quarter beginning after March 31, 2006 (and only during such calendar quarter), if, as of the last day of the preceding calendar quarter, the closing price of our common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of such preceding calendar quarter is more than 120% of the applicable conversion price per share of common stock on the last day of such

13

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

preceding calendar quarter; (ii) during the five business day period after any five consecutive trading day period in which the “trading price” per $1,000 principal amount of notes for each day of that period was less than 98% of the product of the closing price of our common stock and the then applicable conversion rate; (iii) upon a redemption notice; (iv) if a designated event or similar change of control transaction occurs; (v) upon specified corporate transactions; or (vi) during the ten trading day period ending at the close of business on the business day immediately preceding the stated maturity date on the notes.  Upon conversion, we will have the right to deliver, in lieu of shares of our common stock, cash or a combination of cash and shares of common stock, at our option, in an amount per note equal to the applicable conversion rate multiplied by the applicable stock price.

We may redeem for cash all or a portion of the notes at any time on or after February 6, 2013 at specified redemption prices.  Holders of the notes have the right to require us to purchase for cash all or any portion of the notes on February 1, 2013, 2016 and 2021 at a price equal to 100% of the principal amount of the notes plus accrued interest and unpaid interest, if any, to the purchase date.  The notes are senior, unsecured obligations and rank equal in right of payment with all other unsecured and unsubordinated indebtedness.

During the nine-month period ended February 28, 2010, we retired $10,500 par value of our 1.625% convertible notes due March 1, 2014 and $2,000 par value of our 2.25% convertible notes due March 1, 2016.  Collectively, the convertible notes were retired for $9,115 cash, and the gain of $913, after consideration of unamortized debt issuance costs, is recorded in gain on extinguishment of debt on the condensed consolidated statements of operations.

During the nine-month period ended February 28, 2009, we retired $25,279 par value of our 1.75% convertible notes due February 1, 2026, $15,806 par value of our 1.625% convertible notes due March 1, 2014 and $33,975 par value of our 2.25% convertible notes due March 1, 2016 for $48,154 cash, and the gain of $11,392, after consideration of unamortized debt issuance costs, is recorded in gain on extinguishment of debt on the condensed consolidated statements of operations.

At February 28, 2010, the face value of our long-term recourse debt was $355,148 and the estimated fair value was approximately $334,800.  The fair value was estimated using available market information.

Change in method of accounting for Convertible Notes

On June 1, 2009, we adopted a new accounting standard that clarifies the accounting for convertible debt instruments that may be settled wholly or partly in cash when converted, and requires convertible debt to be accounted for as two components: (i) a debt component which is recorded upon issuance at the estimated fair value of a similar straight-debt instrument without the debt-for-equity conversion feature; and (ii) an equity component that is included in capital surplus and represents the estimated fair value of the conversion feature at issuance.  The bifurcation of the debt and equity components results in a discounted carrying value of the debt component compared to the principal amount.  The discount is accreted to the carrying value of the debt component through interest expense over the expected life of the debt using the effective interest method.

The new accounting standard requires retrospective application and impacts the accounting for our 1.625% and 2.25% convertible notes issued in February 2008 and our 1.75% convertible notes issued in February 2006.

14

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

As of February 28, 2010 and May 31, 2009, the long-term debt and equity component (recorded in capital surplus, net of income tax benefit) consisted of the following:

	February 28,			May 31,
	2010			2009
Long-term debt:
Principal amount	$	276,990		$	289,490
Unamortized discount	(53,386		)	(64,775		)
Net carrying amount	$	223,604		$	224,715
Equity component, net of tax	$	74,772		$	75,027

The discount on the liability component of long-term debt is being amortized using the effective interest method based on an effective rate of 8.48% for our 1.75% convertible notes; 6.82% for our 1.625% convertible notes and 7.41% for our 2.25% convertible notes.  For our 1.75% convertible notes, the discount is being amortized through February 1, 2013, which is the first put date for those notes.  For our 1.625% and 2.25% convertible notes, the discount is being amortized through their respective maturity dates of March 1, 2014 and March 1, 2016.

As of February 28, 2010 and 2009, for each of our convertible note issuances, the “if converted” value does not exceed its principal amount.

The interest expense associated with the convertible notes was as follows:

	Three Months Ended February 28,				Nine Months Ended February 28,
	2010		2009		2010		2009
Coupon interest	$	1,273	$	1,513	$	3,833	$	5,074
Amortization of deferred financing fees	193		230		582		751
Amortization of discount	2,944		3,207		8,699		10,357
Interest expense related to convertible notes	$	4,410	$	4,950	$	13,114	$	16,182

15

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

The following tables set forth the effect of the retrospective application of the new accounting standard on certain previously reported items.

Condensed Consolidated Statements of Operations:

	Three Months Ended February 28, 2009
	Previously Reported		Impact from New Standard			As Adjusted
Gain on extinguishment of debt	$	2,109	$	(1,220	)	$	889
Interest expense	4,439		3,104			7,543
Provision for income taxes	7,401		(1,514		)	5,887
Income from continuing operations	20,024		(2,810		)	17,214
Net income attributable to AAR	20,024		(2,810		)	17,214
Earnings per share — basic:
Earnings from continuing operations	$	0.53	$	(0.08	)	$	0.45
Loss from discontinued operations	—		—			—
	$	0.53	$	(0.08	)	$	0.45
Earnings per share — diluted:
Earnings from continuing operations	$	0.48	$	(0.05	)	$	0.43
Loss from discontinued operations	—		—			—
	$	0.48	$	(0.05	)	$	0.43

	Nine Months Ended February 28, 2009
	Previously Reported			Impact from New Standard			As Adjusted
Gain on extinguishment of debt	$	25,317		$	(13,925	)	$	11,392
Interest expense	14,093			10,017			24,110
Provision for income taxes	28,490			(8,380		)	20,110
Income from continuing operations	60,107			(15,562		)	44,545
Net income attributable to AAR	58,158			(15,562		)	42,596
Earnings per share — basic:
Earnings from continuing operations	$	1.58		$	(0.41	)	$	1.17
Loss from discontinued operations	(0.05		)	—			(0.05		)
	$	1.53		$	(0.41	)	$	1.12
Earnings per share — diluted:
Earnings from continuing operations	$	1.43		$	(0.29	)	$	1.14
Loss from discontinued operations	(0.05		)	—			(0.05		)
	$	1.38		$	(0.29	)	$	1.09

16

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

Condensed Consolidated Balance Sheet:

	May 31, 2009
	Previously Reported		Impact from New Standard			As Adjusted
Other assets	$	84,953	$	(1,606	)	$	83,347
Long term debt	367,598		(64,775		)	302,823
Deferred taxes	40,263		23,330			63,593
Capital surplus	330,002		75,027			405,029
Retained earnings	409,847		(35,188		)	374,659

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.

We use the “if converted” method in calculating the diluted earnings per share effect of the assumed conversion of our contingently convertible debt issued in fiscal 2006 because the principal for that issuance can be settled in stock, cash or a combination thereof.  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.

17

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

The following table provides a reconciliation of the computations of basic and diluted earnings per share information for the three- and nine-month periods ended February 28, 2010 and 2009.

	Three Months Ended February 28,				Nine Months Ended February 28,
	2010		2009		2010		2009
Income from continuing operations	$	9,785	$	17,214	$	32,136	$	44,545
Loss from discontinued operations, net of tax	—		—		—		(1,949		)
Loss attributable to noncontrolling interest	127		—		1,292		—
Net income attributable to AAR	$	9,912	$	17,214	$	33,428	$	42,596
Basic shares:
Weighted average common shares outstanding	38,217		38,043		38,154		38,067
Earnings per share — basic:
Earnings from continuing operations	$	0.26	$	0.45	$	0.88	$	1.17
Loss from discontinued operations	—		—		—		(0.05		)
Earnings per share — basic	$	0.26	$	0.45	$	0.88	$	1.12
Net income attributable to AAR	$	9,912	$	17,214	$	33,428	$	42,596
Add: After-tax interest on convertible debt	1,328		1,301		3,924		4,107
Net income for diluted EPS calculation	$	11,240	$	18,515	$	37,352	$	46,703
Diluted shares:
Weighted average common shares outstanding	38,217		38,043		38,154		38,067
Additional shares from the assumed exercise of stock options	265		78		174		66
Additional shares from the assumed vesting of restricted stock	558		211		525		183
Additional shares from the assumed conversion of convertible debt	4,068		4,238		4,068		4,514
Weighted average common shares outstanding — diluted	43,108		42,570		42,921		42,830
Earnings per share — diluted:
Earnings from continuing operations	$	0.26	$	0.43	$	0.87	$	1.14
Loss from discontinued operations	—		—		—		(0.05		)
Earnings per share — diluted	$	0.26	$	0.43	$	0.87	$	1.09

For the nine-month periods ended February 28, 2010 and 2009, respectively, stock options to purchase 381,000 and 928,000 shares of common stock were outstanding, but were not included in the computation of diluted earnings per share, because the exercise price of these options was greater than the average market price of the common shares during the interim periods then ended.

18

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 9 —Aircraft Portfolio

Joint Venture Aircraft

The Company owns aircraft with joint venture partners as well as aircraft that are wholly-owned.  As of February 28 2010, the Company had ownership interests in 27 aircraft with joint venture partners.  As of February 28, 2010, our equity investment in the 27 aircraft owned with joint venture partners was approximately $43,100 and is included in investment in joint ventures on the condensed consolidated balance sheet.

Our aircraft joint ventures represent investments in limited liability companies that are accounted for under the equity method of accounting.  Our membership interest in each of these limited liability companies is 50% and the primary business of these companies is the acquisition, ownership, lease and disposition of certain commercial aircraft.  Aircraft are purchased with cash contributions by the members of the companies and debt financing provided to the limited liability companies on a limited recourse basis.  Under the terms of servicing agreements with certain of the limited liability companies, we provide administrative services and technical advisory services, including aircraft evaluations, oversight and logistical support of the maintenance process and records management.  We also provide remarketing services with respect to the divestiture of aircraft by the limited liability companies.  For the nine-month periods ended February 28, 2010 and 2009, we were paid $580 and $700, respectively, for such services.  The income tax benefit or expense related to the operations of the ventures is recorded by the member companies.

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

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

	Three Months Ended February 28,				Nine Months Ended February 28,
	2010		2009		2010		2009
Sales	$	11,411	$	12,677	$	33,845	$	56,344
Income before provision for income taxes	312		3,014		840		15,268

	February 28, 2010		May 31, 2009
Balance sheet information:
Assets	$	267,909	$	282,772
Debt	173,822		194,388
Members’ capital	90,823		85,268

19

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

Wholly-Owned Aircraft

In addition to the aircraft owned with joint venture partners, we own five aircraft for our own account that are considered wholly-owned.  Of the five aircraft, two aircraft were financed with non-recourse debt, one aircraft was financed with a non-recourse capital lease and the other two have no debt.  A former lessee of two of our wholly-owned aircraft is in arrears for amounts due under the leases.  We have obtained a judgment against the lessee and its affiliated guarantor and expect to recover past due rental amounts.  Our net investments in these two aircraft after consideration of non-recourse financing are $6,666 and $3,821, respectively.  Our investment in the five wholly-owned aircraft is comprised of the following components:

	February 28, 2010			May 31, 2009
Gross carrying value	$	51,012		$	61,202
Non-recourse debt	(17,367		)	(19,190		)
Non-recourse capital lease obligation	(8,913		)	(10,259		)
Net AAR investment	$	24,732		$	31,753

Information relating to aircraft type, year of manufacture, lessee, lease expiration date and expected disposition upon lease expiration for the 27 aircraft owned with joint venture partners and five wholly-owned aircraft is as follows:

Aircraft owned with joint venture partners

Quantity	Aircraft Type	Year Manufactured	Lessee	Lease Expiration Date (FY)	Post-Lease Disposition
3	737-300	1987	US Airways	2011	Re-lease/Disassemble
2	767-300	1991	United Airlines	2016 and 2017	Re-lease
1	757-200	1989	US Airways	2012	Forward Sale 11/2011
1	747-400	1989	Northwest Airlines	2014	Re-lease/Disassemble
1	737-300	1997	flyLAL Charters	2012	Re-lease
1	A320	1992	Air Canada	2015	Disassemble
18	737-400	1992-1997	Malaysia Airlines	Various(1)	Re-lease
27

Wholly-owned aircraft

Quantity	Aircraft Type	Year Manufactured	Lessee	Lease Expiration Date (FY)	Post-Lease Disposition
1	MD83	1989	Meridiana	2010	Re-lease
2	A320	1992, 1997	available	—	Re-lease
1	A320	1992	Air Canada	2015	Re-lease
1	CRJ 200	1999	Air Wisconsin	2018	Sale/Disassemble
5

(1) 6 aircraft in 2010; 3 aircraft in 2011; 8 aircraft in 2012; and 1 aircraft in 2013

20

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

Note 10 — Business Segment Information

We report our activities in three business segments: Aviation Supply Chain; Maintenance, Repair and Overhaul; and Structures and Systems.  In the first quarter of fiscal 2010, we combined our Aircraft Sales and Leasing segment with our Aviation Supply Chain segment.  We made this change as the aircraft sales and leasing business has economic characteristics increasingly similar to those of the Aviation Supply Chain segment and in consideration of the decreased significance of aircraft sales and leasing to our overall business activities.  Prior year segment data has been restated to reflect the change.

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 parts and components.  We also offer customized programs for inventory supply and management and performance-based logistics.  Sales also include the sale and lease of aircraft and commercial jet engines and technical and advisory services.  Cost of sales consists principally of the cost of product (primarily aircraft and engine parts and aircraft), direct labor, overhead (primarily indirect labor, facility cost and insurance) and the cost of lease revenue (primarily depreciation and insurance).

Sales in the Maintenance, Repair and Overhaul segment are principally derived from aircraft maintenance and the repair and overhaul of landing gear.  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 engineering, design and manufacture of containers, pallets and shelters used to support the U.S. military’s tactical deployment requirements, complex machined and fabricated parts, components and sub-systems for various aerospace and defense programs and other applications, in-plane cargo loading and handling systems for commercial and military applications and composite products for aviation and industrial use.  Cost of sales consists principally of the cost of product, direct labor and overhead.

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, 2009.  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.

21

AAR CORP. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

February 28, 2010

(Unaudited)

(Dollars in thousands, except per share amounts)

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

	Three Months Ended February 28,				Nine Months Ended February 28,
	2010		2009		2010		2009
Sales:
Aviation Supply Chain	$	122,579	$	141,808	$	398,135	$	450,056
Maintenance, Repair and Overhaul	70,085		76,951		220,202		250,698
Structures and Systems	116,943		120,033		361,477		351,514
	$	309,607	$	338,792	$	979,814	$	1,052,268

	Three Months Ended February 28,				Nine Months Ended February 28,
	2010		2009		2010		2009
Gross profit:
Aviation Supply Chain	$	23,947	$	36,021	$	75,834	$	89,402
Maintenance, Repair and Overhaul	8,589		10,856		27,943		37,112
Structures and Systems	26,389		17,748		73,031		54,058
	$	58,925	$	64,625	$	176,808	$	180,572

22

AAR CORP. and Subsidiaries

February 28, 2010

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Dollars in thousands)

General Overview

We report our activities in three business segments:  Aviation Supply Chain; Maintenance, Repair and Overhaul; and Structures and Systems.  The table below sets forth consolidated sales for our three business segments for the three- and nine-month periods ended February 28, 2010 and 2009.

	Three Months Ended February 28,				Nine Months Ended February 28,
	2010		2009		2010		2009
Sales:
Aviation Supply Chain	$	122,579	$	141,808	$	398,135	$	450,056
Maintenance, Repair and Overhaul	70,085		76,951		220,202		250,698
Structures and Systems	116,943		120,033		361,477		351,514
	$	309,607	$	338,792	$	979,814	$	1,052,268

Over the past year and a half, many U.S. carriers announced a series of cost reduction initiatives, including staffing reductions, route consolidations and capacity reductions.  Earlier actions were principally in response to high oil prices, while more recent actions have been in response to weak economic conditions both in the U.S. and most other industrialized nations.  Capacity in North America was down approximately 4.5% during the fourth calendar quarter of 2009 compared to the prior year.  Certain foreign carriers have also reduced capacity in response to weak world-wide economic conditions.  The reduction in the global operating fleet of passenger and cargo aircraft has resulted in reduced demand for parts support and maintenance activities for the types of aircraft affected.  While we may be in the midst of a recovery, the airlines are moving slowly to add capacity.

Although financial markets have calmed, disruptions in financial markets over the past 18 months, including tightened credit markets, reduced the amount of liquidity available to certain of our customers which, in turn, impacted their ability to buy parts, services, engines and aircraft.  We continue to monitor economic conditions for their impact on our customers and markets, assessing both risks and opportunities that may affect our business.

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

During the nine-months ended February 28, 2010, sales to global defense customers increased 4.3% and represented 47.2% of consolidated sales.  We continue to see opportunities to provide performance-based logistics services and manufactured products supporting our defense customers’ requirements.  Although it remains difficult for us to predict long-term demand for these types of products and services, we believe we are well-positioned with our current portfolio of products and services and growth plans to benefit from longer-term U.S. military deployment and program management strategies.

Firm backlog at February 28, 2010 was approximately $365,000 compared to $492,500 at May 31, 2009.  The decline in backlog since May 31, 2009 reflects a reduction at our Mobility Systems business unit which is in our Structures and Systems segment.  Backlog at February 28, 2010 does not include expected sales of cargo systems of approximately $325,000 from the A400M program, which is currently expected to be revenue producing in late fiscal 2012 or early fiscal 2013. Backlog also does not include the value of expected sales from the recently awarded KC-10 program, which is estimated to be $60,000 to $70,000 on an annual basis.

23

Results of Operations

Three-Month Period Ended February 28, 2010

Consolidated sales for the third quarter ended February 28, 2010 decreased $29,185 or 8.6% compared to the prior year period.  Sales to commercial customers declined 14.5% compared to the prior year as airlines reduced inventory levels and maintenance visits in response to uncertain economic conditions and lower capacity.  Sales to defense customers declined 1.2%, principally due to lower sales in the Structures and Systems segment.

In the Aviation Supply Chain segment, sales declined $19,229 or 13.6% versus the prior year reflecting lower demand for aftermarket parts support as airlines reduced inventory purchases.  Sales were also unfavorably impacted by the January 2010 bankruptcy filing of Mesa Air Group, Inc. (“Mesa”).  Sales to Mesa in this segment were approximately $6,200 for the three-month period ended February 28, 2010, compared to $9,600 in the prior year three-month period.  Gross profit in the Aviation Supply Chain segment decreased $12,074 or 33.5% and the gross profit margin percentage decreased to 19.5% from 25.4% in the prior year.  The decline in gross profit and the gross profit margin percentage was driven by lower sales volume and continued pricing pressure from our airline customers as they continued their focus of lowering costs and conserving cash.

In the Maintenance, Repair and Overhaul segment, sales declined $6,866 or 8.9% versus the prior year reflecting the completion of a major program in early fiscal 2010 and fewer maintenance visits by our airline customers due to lower capacity.  Sales were also unfavorably impacted by the January 2010 bankruptcy filing of Mesa.  Sales to Mesa in this segment were approximately $4,200 for the three-month period ended February 28, 2010, compared to $6,900 in the prior year three-month period.  Gross profit in the Maintenance, Repair and Overhaul segment declined $2,267 or 20.9% and the gross profit margin percentage declined to 12.3% from 14.1% in the prior year principally as a result of lower volume.

In the Structures and Systems segment, sales declined $3,090 or 2.6%, versus the prior year, reflecting lower sales of precision machined parts, cargo systems and composite structures.  Sales of specialized mobility products increased during the current three-month period ended February 28, 2010.  Gross profit in the Structures and Systems segment increased $8,641 or 48.7% and the gross profit margin increased to 22.6% from 14.8% due to cost reduction and process improvement initiatives and the favorable mix of products sold.

Operating income decreased $6,438 or 21.9% compared with the prior year primarily due to the reduction in sales and gross profit in the Aviation Supply Chain and Maintenance, Repair and Overhaul segments, as well as a decline in earnings from joint ventures.  Selling, general and administrative expenses declined $607 from the prior year as we have adjusted our cost structure in response to lower sales.  Earnings from joint ventures declined $1,345 or 96.0%, principally due to increased depreciation expense recorded in the aircraft joint ventures as a result of reducing the useful lives of certain narrow-body aircraft to 25 years, as well as fewer aircraft owned in joint ventures as compared to the prior year.  Net interest expense declined $857 or 11.8% compared to the prior year due to a reduction in outstanding borrowings.  The loss on investment of $1,876 principally reflects the reduction in carrying value to $0 of Mesa equity shares that were received in November 2009 in connection with a contract restructuring.  The Company is currently prohibited from selling the equity shares by order of the U.S. Bankruptcy Court. 

Our effective income tax rate increased to 33.7% in the third quarter of fiscal 2010 compared to 25.5% last year.  The effective income tax rate last year was favorably impacted by $1,900 of additional research and development tax credits that were identified upon completion of our fiscal 2009 federal income tax return.

24

Effective June 1, 2009, we adopted a new accounting standard for convertible debt that requires retrospective application and as a result, operating results for the three- and nine-month periods ended February 28, 2009 have been restated (see Note 7 in Notes to Condensed Consolidated Financial Statements.)  In addition, effective June 1, 2009, we adopted a new accounting standard related to the accounting for noncontrolling interests.  The loss attributable to noncontrolling interest of $127 on the condensed consolidated statements of operations represents the joint venture partners’ share of the net loss of the consolidated joint venture during the third quarter of fiscal 2010.

Nine-Month Period Ended February 28, 2010

Consolidated sales for the nine-months ended February 28, 2010 decreased $72,454 or 6.9% compared to the prior year period.  Sales to commercial customers declined 15.0% compared to the prior year as airlines continued to reduce inventory levels and maintenance visits in response to weak economic conditions and tight credit markets.  Sales to defense customers increased 4.3%, reflecting higher shipments of specialized mobility systems products.

In the Aviation Supply Chain segment, sales declined $51,921 or 11.5% as compared to the prior year, reflecting lower demand for aftermarket parts support as airlines continued to reduce inventory levels in response to weak economic conditions.  Gross profit in the Aviation Supply Chain segment declined $13,568 or 15.2% and the gross profit margin percentage decreased to 19.0% from 19.9% in the prior year. Current year gross profit was negatively impacted by lower volumes and pricing pressures from our airline customers as they seek ways to further lower costs and conserve cash, as well as by the impact of the sale of an interest in an aircraft leveraged lease during the first quarter, on which the Company recorded a $3,800 negative gross profit margin.  Prior year gross profit was negatively impacted by a $21,033 pre-tax charge to reduce the carrying value of three aircraft to their fair value.

In the Maintenance, Repair and Overhaul segment, sales declined $30,496 or 12.2% versus the prior year, reflecting the completion of two programs during the second quarter and fewer maintenance visits by our airline customers due to reduced capacity.  Gross profit in the Maintenance, Repair and Overhaul segment declined $9,169 or 24.7% and the gross profit margin percentage declined to 12.7% from 14.8% in the prior year principally as a result of lower volume.

In the Structures and Systems segment, sales increased $9,963 or 2.8% versus the prior year, reflecting increased shipments for specialized mobility products.  Gross profit in the Structures and Systems segment increased $18,973 or 35.1%, and the gross profit margin percentage increased to 20.2% from 15.4% in the prior year due to cost reduction and process improvement initiatives, favorable product mix and increased volume.

Operating income decreased $9,700 or 12.7% compared with the prior year due to the impact from the reduction of sales and gross profit in the Aviation Supply Chain and Maintenance, Repair and Overhaul segments, as well as a reduction in earnings from unconsolidated joint ventures.  Selling, general and administrative expenses were essentially flat with the prior year, even while including approximately $6,100 of expense associated with the launch of AAR Global Solutions in fiscal 2010.  Earnings from joint ventures declined $7,063 or 97.9%, principally due to increased depreciation expense recorded in the aircraft joint ventures as a result of reducing the useful lives of certain narrow-body aircraft to 25 years, as well as fewer aircraft owned in joint venture as compared to the prior year.  Net interest expense declined $4,148 or 18.1% compared to the prior year due to a reduction in outstanding borrowings.  The loss on investment of $1,876 principally reflects the reduction in carrying value to $0 of Mesa equity shares that were received in November 2009 in connection with a contract restructuring.  The Company is currently prohibited from selling the equity shares by order of the U.S. Bankruptcy Court.  Our effective income tax rate increased slightly to 31.3% in fiscal 2010 compared to 31.1% last year.

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During the nine months ended February 28, 2010, we retired $10,500 par value of our 1.625% convertible notes and $2,000 par value of our 2.25% convertible notes, resulting in a net gain on extinguishment of debt of $913.

Effective June 1, 2009, we adopted a new accounting standard related to convertible debt that requires retrospective application and as a result, operating results for the three- and nine-month periods ended November 30, 2008 have been restated (see Note 7 in Notes to Condensed Consolidated Financial Statements.)  In addition, effective June 1, 2009, we adopted a new standard related to the accounting for noncontrolling interest for AAR Global Solutions.  The loss attributable to noncontrolling interest of $1,292 on the condensed consolidated statements of operations represents the joint venture partners’ share of the net loss of the joint venture during the first nine months of fiscal 2010.

Liquidity and Capital Resources

Historically, we have funded our operating activities and met our commitments through the generation of cash from operations, augmented by the periodic issuance of common stock and debt in the public and private markets.  In addition to these cash sources, our current capital resources include our unsecured credit facility.  We continually evaluate various financing arrangements, including the issuance of common stock or debt, which would allow us to improve our liquidity position and finance future growth on commercially reasonable terms. Our continuing ability to borrow from our lenders and issue debt and equity securities to the public and private markets in the future may be negatively affected by a number of factors, including the overall health of the credit markets, general economic conditions, airline industry conditions, geo-political events, including the war on terrorism, and our operating performance.  Our ability to generate cash from operations is influenced primarily by our operating performance and changes in working capital. Under a universal shelf registration statement filed with the Securities and Exchange Commission that became effective on December 12, 2008, we may offer and sell up to $300,000 of various types of securities, including common stock, preferred stock and medium-term or long-term debt securities, subject to market conditions.

At February 28, 2010, our liquidity and capital resources included cash and cash equivalents of $117,526 and working capital of $625,252.  Our revolving credit agreement, as amended (the “Credit Agreement”) with various financial institutions, as lenders, and Bank of America National Association as successor by merger to LaSalle Bank National Association (“Bank of America”), as administrative agent for the lenders, provides us with unsecured revolving borrowing capacity of up to $250,000.  Under certain circumstances, we may request an increase to the revolving commitment by an aggregate amount of up to $75,000, not to exceed $325,000 in total.   The term of our Credit Agreement extends to August 31, 2011.  Borrowings under the Credit Agreement bear interest at the London Interbank Offered Rate (“LIBOR”) plus 100 to 237.5 basis points based on certain financial measurements.  Borrowings outstanding under this facility at February 28, 2010 were $0, and there were $10,420 of outstanding letters of credit which reduced the availability of this facility.  In addition to our Credit Agreement, we also have $3,378 available under a foreign line of credit.

During the nine-month period ended February 28, 2010, cash flow from operations was $94,647 primarily as a result of a reduction in accounts receivable of $22,159, and a reduction in inventories and equipment on short-term lease of $31,928.  Cash flow from operations also benefitted from net income attributable to AAR and noncontrolling interest and depreciation and amortization of $67,444, partially offset by a decrease in accounts payable and accrued liabilities of $21,463.

During the nine-month period ended February 28, 2010, our investing activities used $20,097 of cash principally as a result of capital expenditures of $20,749, which mainly represents capacity

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expansion and capability improvements in our Structures and Systems and Maintenance, Repair and Overhaul segments.

During the nine-month period ended February 28, 2010, our financing activities used $69,438 of cash primarily due to a reduction in borrowings of $70,204, which includes the retirement of convertible notes for $9,115 cash, the payoff of non-recourse debt of $11,083 and the payoff of borrowings outstanding under our Credit Agreement of $50,000.

Critical Accounting Policies and Significant Estimates

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

Allowance for Doubtful Accounts

Our allowance for doubtful accounts is intended to reduce the value of customer accounts receivable to amounts expected to be collected.  In determining the required allowance, we consider factors such as general and industry-specific economic conditions, customer credit history, and our customer’s current and expected future financial performance.

Goodwill

Goodwill and other intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment tests. The Company reviews and evaluates its goodwill and indefinite life intangible assets for potential impairment at a minimum annually, on May 31, or more frequently if circumstances indicate that impairment is possible. We use a two step process to evaluate goodwill for impairment.  In the first step, we compare the fair value of each reporting unit with the carrying value of the reporting unit, including goodwill.  We estimate the fair value of each reporting unit using a valuation technique based on a multiple of earnings or discounted cash flows.  If the estimated fair value of the reporting unit is less than the carrying value of the reporting unit, we would be required to complete a second step to determine the amount of goodwill impairment.  In the second step, we would determine an implied fair value of the reporting unit’s goodwill by allocating the reporting unit’s fair value to all of the assets and liabilities other than goodwill.  We then would compare the implied fair value of goodwill to the carrying amount and recognize the difference as an impairment charge.

The assumptions we use to estimate the fair value of our reporting units are based on historical performance as well as forecasts used in our current business plan.

The amount reported under the caption “Goodwill and other intangible assets, net” is comprised of goodwill and intangible assets associated with acquisitions we made, principally since the beginning of fiscal 1998.

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Inventories

Inventories are valued at the lower of cost or market.  Cost is determined by the specific identification, average cost or first-in, first-out methods.  Provisions are made for excess and obsolete inventories and inventories that have been impaired as a result of industry conditions.  We have utilized certain assumptions when determining the market value of inventories, such as historical sales of inventory, current and expected future aviation usage trends, replacement values and expected future demand.  Reductions in demand for certain of our inventories or declining market values, as well as differences between actual results and the assumptions utilized by us when determining the market value of our inventories, could result in the recognition of impairment charges in future periods.

During the fourth quarter of fiscal 2009, we recorded a $10,100 pre-tax impairment charge on inventory and engines which had been acquired prior to September 11, 2001.  This inventory was also subject to impairment charges recorded in previous fiscal years.  The fiscal 2009 impairment charge was triggered by declining conditions in the commercial aviation industry and a slowdown in the sales volume of these assets during the fiscal year.

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.

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.  We have utilized certain assumptions to estimate future undiscounted cash flows, including current and future lease rates, lease terms, residual values and market conditions and trends impacting future demand.  Differences between actual results and the assumptions utilized by us when determining undiscounted cash flows could result in future impairments of aircraft and engines which are currently being leased or are available for lease.

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

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Program Development Costs

In June 2005, we announced that our Cargo Systems business was selected to provide cargo handling systems for the new Airbus A400M Military Transport Aircraft (“A400M”).  We are a subcontractor to Pfalz Flugzeugwerke GmbH (“PFW”) on this Airbus program.  Our portion of the revenue from this program is expected to exceed $300,000 through fiscal 2020, based on sales projections of the A400M.  During fiscal 2009, Airbus agreed to reimburse AAR and PFW 20.0 million euros for costs incurred to develop the A400M system.  AAR’s share of this reimbursement was $18,700 and reduced the amount of capitalized program development costs.  As of February 28, 2010, we have capitalized, net of the $18,700 reimbursement, approximately $49,800 of costs associated with the engineering and development of the cargo system.  Sales and related cost of sales will be recognized on the units of delivery method.  In determining the recoverability of the capitalized program development costs, we have utilized certain judgments and estimates concerning expected revenues and the cost to manufacture the A400M cargo system.  Differences between actual results and the assumptions utilized by us may result in us not fully recovering the value of the program development costs, which would unfavorably impact our financial condition and results of operations.

Pension Plans

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

Our discount rate is determined based on a review of long-term, high quality corporate bonds as of May 31, 2009, and models that match projected benefit payments to coupons and maturities from the high quality bonds.  The assumption for the expected long-term return on plan assets is developed through analysis of historical asset returns by investment category, our fund’s actual return experience and current market conditions.  Changes in the discount rate and differences between expected and actual return on plan assets may impact the amount of net periodic pension expense recognized in our condensed consolidated statement of operations.

New Accounting Standards

In June 2009, the Financial Accounting Standards Board (“FASB”) issued an updated standard that addresses information a reporting entity provides in its financial statements about the transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement in transferred financial assets.  It also removes the concept of a qualifying special purpose entity, limits the circumstances in which a transferor derecognizes a portion or component of a financial asset, defines participating interest and enhances the information disclosed to financial statement users to provide greater transparency.  The new standard is effective for the first annual reporting period beginning after November 15, 2009 and will be effective for AAR as of June 1, 2010.  We are currently evaluating the impact of the adoption of this new guidance on our consolidated financial statements, but do not anticipate that its effect will be material.

In June 2009, the FASB issued an updated standard that requires an enterprise to perform an analysis to determine the primary beneficiary of a variable interest entity; to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity and to eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity.  It also requires enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity.  The new standard is effective for the first annual reporting period beginning after November 15, 2009 and will be effective for AAR as of June 1, 2010.  We are currently evaluating the impact of the adoption of this new guidance on our consolidated financial statements, but do not anticipate that its effect will be material.

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In June 2009, the FASB issued “The FASB Accounting Standards CodificationTM” which is now the source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities.  Future accounting pronouncements will be designed to update the Codification and will be referred to as Accounting Standards Updates.  The standard was effective for us in our second quarter of fiscal 2010 and had no impact 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” and to those set forth under Part I, Item 1A in our Annual Report on Form 10-K for the year ended May 31, 2009.  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 update 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 were no material changes to our market risk as set forth in Item 7A of our Annual Report on Form 10-K for the year ended May 31, 2009.

Item 4 — Controls and Procedures

As required by Rules 13a-15(e) and 15d-15(e) of the Exchange Act, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of February 28, 2010.  This evaluation was carried out under the supervision and with participation of our Chief Executive Officer and Chief Financial Officer.  There are inherent limitations to the effectiveness of any system of disclosure controls and procedures.  Therefore, effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives.  Based upon our evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of February 28, 2010.

There were no changes in our internal control over financial reporting during the third quarter ended February 28, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 1A — Risk Factors

There have been no material changes to our risk factors as set forth in our Annual Report on Form 10-K for the year ended May 31, 2009, except as follows:

Mesa Airlines

Since 2005, Mesa Air Group, Inc. (“Mesa”) has been a significant customer of the Company.  During fiscal 2009, total sales to Mesa were $70,700, of which $45,500 was in the Aviation Supply Chain segment (of which approximately $29,000 related to the ERJ 145 and CRJ 200 aircraft) and $25,200 was in the Maintenance, Repair and Overhaul segment (of which approximately $9,000 related to the ERJ 145 and CRJ 200 aircraft).  In May 2008, Mesa warned it may have to file for bankruptcy protection if it could not resolve a major contract dispute with one of its customers.  In November 2009, the Company and Mesa amended their parts supply and maintenance agreements for the ERJ 145 and CRJ 200 aircraft types to provide Mesa with increased flexibility to respond to demand fluctuations in the 50-seat aircraft market.

On January 5, 2010, Mesa and subsidiaries filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code.  As a result, we wrote off certain pre-petition accounts receivable due from Mesa.  Further, we reduced to $0 the carrying value of Mesa equity shares we received from Mesa as part of the November 2009 contract amendment.

Based upon our understanding of Mesa’s requirements and subject to its restructuring plan, we expect annual sales to Mesa to now approximate $45,000.  At February 28, 2010, we have long-term assets recorded in equipment on long-term lease of $39,200 supporting the Mesa supply chain programs.  At February 28, 2010, we also have post-petition trade accounts receivable and other assets associated with Mesa of approximately $7,900.  If Mesa significantly reduces or eliminates a portion of its remaining aircraft fleet, or if Mesa is not able to emerge from its bankruptcy proceedings, our results of operations and financial position could be negatively affected.

Item 6 — Exhibits

The exhibits to this report are listed on the Exhibit Index included elsewhere herein.  Management contracts and compensatory arrangements have been marked with an asterisk (*) on the Exhibit Index.

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SIGNATURES

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:	March 19, 2010	/s/ RICHARD J. POULTON
		Richard J. Poulton
		Vice President, Chief Financial Officer and Treasurer
		(Principal Financial Officer and officer duly
		authorized to sign on behalf of registrant)
		/s/ MICHAEL J. SHARP
		Michael J. Sharp
		Vice President, Controller and Chief Accounting Officer
		(Principal Accounting Officer)

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EXHIBIT INDEX

Exhibit No.	Description	Exhibits
31.	Rule 13a-14(a)/15(d)-14(a) Certifications	31.1	Section 302 Certification dated March 19, 2010 of David P. Storch, Chairman and Chief Executive Officer of Registrant (filed herewith).
		31.2	Section 302 Certification dated March 19, 2010 of Richard J. Poulton, Vice President, Chief Financial Officer and Treasurer of Registrant (filed herewith).
32.	Section 1350 Certifications	32.1	Section 906 Certification dated March 19, 2010 of David P. Storch, Chairman and Chief Executive Officer of Registrant (filed herewith).
		32.2	Section 906 Certification dated March 19, 2010 of Richard J. Poulton, Vice President, Chief Financial Officer and Treasurer of Registrant (filed herewith).

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