We use the intrinsic value method to account for stock-based employee compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and therefore we do not recognize compensation expense in association with options granted at or above the market price of our common stock at the date of grant. The following table presents a reconciliation of reported net earnings and per share information to pro forma net earnings and per share information that would have been reported if the fair value method had been used to account for stock-based employee compensation:

      We recognize sales when delivery of product has occurred or services have been rendered and there is persuasive evidence of a sales arrangement, selling prices are fixed or determinable, and collectibility from the customer is reasonably assured. We consider product delivery to have occurred when the customer has taken title and assumed the risks and rewards of ownership of the products. Most of our sales are made directly to customers that use our products, although we also sell products to distributors, dealers, and independent service facilities. Sales terms for distributors, dealers, and independent service facilities are identical to our sales terms for direct customers. We account for payments made to customers as a reduction of revenue unless

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

they are made in exchange for identifiable goods or services with fair values that can be reasonably estimated. These reductions in revenues are recognized immediately to the extent that the payments cannot be attributed to expected future sales, and are recognized in future periods to the extent that the payments relate to future sales, based on the specific facts and circumstances underlying each payment.

      In November 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 151, “Inventory Costs.” The Statement clarifies that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current-period charges. This Statement also requires that allocations of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The Statement becomes effective for our fiscal year beginning October 1, 2005. We currently do not expect that application of this Statement will have any material effect on our financial statements.

      In December 2004, the Financial Accounting Standards Board issued a revised Statement of Financial Accounting Standards No. 123, “Share-Based Payment.” Among its provisions, the revised Statement will require us to measure the cost of employee services in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize the cost over the requisite service period. In accordance with a Securities and Exchange Commission rule issued in April 2005, this revised statement becomes effective for our fiscal year beginning October 1, 2005, although early adoption is allowed. As described in Note 2 to these financial statements, we currently use the intrinsic value method to account for stock-based employee compensation. As a result, adoption of this revised Statement is expected to reduce our net earnings in interim and annual periods after adoption. We believe the best indication of the approximate immediate net earnings effect of adopting the provisions of this revised Statement may be determined by reviewing Note 2 to these financial statements and Note 1 to Consolidated Financial Statements on page 39 of the 2004 annual report to shareholders, which was filed with our Form 10-K/ A Amendment No. 1 for the year ended September 30, 2004. These notes show that net earnings would have decreased by $0.03 per diluted share for the quarter ended March 31, 2005, $0.05 per diluted share for the six months ended March 31, 2005, and $0.11 per diluted share for the year ended September 30, 2004. Also, upon adoption we will be allowed to, but not required to, restate prior years in accordance with a prescribed modified retrospective method or, in the event of early adoption of the revised statement this fiscal year, restate prior interim periods in accordance with a prescribed modified retrospective method. We have not yet determined whether we will adopt the revised statement this fiscal year or wait until the required effective date of next fiscal year and we have not yet determined whether we will restate prior periods.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following stock options were outstanding during the three and six months ended March 31, 2005 and 2004, but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares during the respective periods:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Amortization expense associated with current intangibles is expected to be approximately $7,100,000 for 2005, $7,000,000 for 2006, $6,600,000 in 2007, $5,900,000 for 2008, and $5,500,000 for 2009.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Salaries and other member benefits include accrued termination benefits totaling $10,005,000 at March 31, 2005 and $12,000,000 at September 30, 2004. These accrued termination benefits were in Industrial Controls. Changes in accrued termination benefits for the six months ended March 31, 2005 were as follows:

      The amounts expensed during the six-month period were for termination benefits earned by members over the period and are primarily related to the consolidation of two European manufacturing operations with existing operations. This action is being taken to streamline the organization by eliminating redundant manufacturing operations and is expected to be substantially complete by March 31, 2006. The total expense for this action is currently estimated to be approximately $15,400,000, of which $12,557,000 was recognized through March 31, 2005. The remaining estimated amount of $2,843,000 is for termination benefits that will be earned by members over their remaining service period and for other costs primarily associated with moving equipment and inventory to other locations. The accrual adjustments reflected in the preceding table were made as a result of changes in estimates for termination benefits payable. These estimates changed because of voluntary member resignations, the currently expected transfer of members to a third-party distributor, and more members electing early retirement options at a lower cost.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Provisions of our sales agreements include product warranties customary to such agreements. We establish accruals for specifically identified warranty issues that are probable to result in future costs. We also accrue for warranty costs on a non-specific basis whenever past experience indicates a normal and predictable pattern exists. A reconciliation of accrued product warranties from September 30, 2004, to March 31, 2005, follows:

      We provide various benefits to eligible members of our company, including pension benefits associated with defined benefit plans and retirement healthcare benefits. Components of net periodic benefit cost and company contributions for these plans were as follows:

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      On May 3, 2005, we announced amendments to one of our retirement healthcare benefit plans that will result in the recognition of a curtailment gain in the third quarter of fiscal year 2005 and will reduce our future net periodic benefit cost. We currently expect the curtailment gain to be in the range of $7,000,000 to $8,000,000. The future reduction in net periodic benefit cost resulting from the plan amendment has not yet been determined. Our future net periodic benefit cost will be affected by the measurement of plan benefit obligations as of May 3, 2005, which we expect to complete in our third quarter.

      Accumulated other comprehensive earnings, which totaled $14,183,000 at March 31, 2005, consisted of the following items:

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      We are currently involved in pending or threatened litigation or other legal proceedings regarding employment, product liability, and contractual matters arising from the normal course of business. We accrued for individual matters that we believe are likely to result in a loss when ultimately resolved using estimates of the most likely amount of loss. There are also individual matters that we believe the likelihood of a loss when ultimately resolved is less than likely but more than remote, which were not accrued. While it is possible that there could be additional losses that have not been accrued, we currently believe the possible additional loss in the event of an unfavorable resolution of each matter is less than $5,000,000 in the aggregate.

      We also file income tax returns in various jurisdictions worldwide, which are subject to audit. We have accrued for our estimate of the most likely amount of expenses that we believe will result from income tax audit adjustments.

      In the event of a change in control of the company, we may be required to pay termination benefits to certain executive officers.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The difference between the total of segment earnings and the statements of consolidated earnings follows:

      Segment assets were as follows:

      We prepared the following discussion and analysis to help you better understand our financial condition, changes in our financial condition, and results of operations. This discussion should be read with the consolidated financial statements.

Overview

      Our business is focused on the design, manufacture, and servicing of energy control systems and components for aircraft and industrial engines, turbines, and other power equipment. We use technologies in the areas of fuel systems, combustion control, electronic controls and software, and systems integration to develop components and integrated systems that we sell to OEMs (original equipment manufacturers) for use in power equipment for the power generation, process industries, transportation, and aerospace markets.

      We have two operating segments — Industrial Controls and Aircraft Engine Systems. Industrial Controls provides energy control systems and components primarily to OEMs of industrial engines, turbines, and other power equipment. Aircraft Engine Systems provides energy control systems and components primarily to OEMs of aircraft turbines. We use segment information internally to assess the performance of each segment and to make decisions on the allocation of resources.

      There has been a lot of volatility in the markets we serve in recent years, and our sales and earnings reflect the results of that volatility. While we saw improved market conditions in 2004, they were still not at the levels they were before the declines that began in 2002. Our second quarter and first half of 2005 reflected improved market conditions over the corresponding periods a year ago, approximately in line with the fourth quarter of last year.

      The changes in our markets have affected our decisions in managing our workforce. We will be implementing actions in 2005 and the first half of 2006 to consolidate certain manufacturing operations in The Netherlands, United Kingdom, and Japan with existing operations in the United States, Germany, and China. Once fully implemented, we expect these actions will generate annual savings of $9 million to $11 million on a pretax basis. The related cost for the actions is currently estimated at $15.4 million. We recognized approximately $12.6 million of this cost through the second fiscal quarter of 2005.

      In the sections that follow, we are providing information to help you better understand factors that may affect our future results, our critical accounting policies and market risks, our results of operations and financial condition, and the effects of recent accounting pronouncements.

Factors That May Affect Future Results

      This Form 10-Q contains forward-looking statements, including:

      Forward-looking statements do not reflect historical facts. Rather, they are statements about future events and conditions and often include words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “target,” “can,” “could,” “may,” “should,” “will,” “would” or similar expressions. Such statements reflect our expectations about the future only as of the date they are made. We are not obligated to, and we might not, update our forward-looking statements to reflect changes that occur after the date they are made. Furthermore, actual results could differ materially from projections or any other forward-looking statement regardless of when they are made.

      Important factors that could individually, or together with one or more other factors, affect our business, results of operations and/or financial condition are discussed more fully in the Management Discussion and

Analysis on pages 15-16 of our 2004 annual report to shareholders, which was filed with our Form 10-K/ A Amendment No. 1 for the year ended September 30, 2004.

Critical Accounting Policies

      We consider the accounting policies used in preparing our financial statements to be critical accounting policies when they are both important to the portrayal of our financial condition and results of operation, and require us to make difficult, subjective, or complex judgments. Critical accounting policies normally result from the need to make estimates about the effect of matters that are inherently uncertain. Management has discussed the development and selection of our critical accounting policies with the audit committee of the company’s Board of Directors. In each of the areas that were identified as critical accounting policies, our judgments, estimates, and assumptions are impacted by conditions that change over time. As a result, in the future there could be changes in our assets and liabilities, increases or decreases in our expenses, and additional losses or gains that are material to our financial condition and results of operations. Our critical accounting policies are discussed more fully in the Management Discussion and Analysis on pages 16-19 of our 2004 annual report to shareholders, which was filed with our Form 10-K/ A Amendment No. 1 for the year ended September 30, 2004.

Market Risks

      Our long-term debt is sensitive to changes in interest rates. Also, assets, liabilities, and commitments that are to be settled in cash and are denominated in foreign currencies for transaction purposes are sensitive to changes in currency exchange rates. These market risks are discussed more fully in the Management Discussion and Analysis on page 19 of our 2004 annual report to shareholders, which was filed with our Form 10-K/ A Amendment No. 1 for the year ended September 30, 2004. However, we currently do not have any existing interest rate swap agreements.

Results of Operations

      Consolidated net sales increased in both the three months and six months ended March 31, 2005, as compared to the same periods a year ago. Industrial Controls benefited from a broad industrial recovery that encompassed power generation, transportation, and process industries, including the mobile industrial and marine markets. In particular, we have experienced higher demand for large gas turbine combustion products — the area affected most by the severe market declines of 2002 and 2003 — and diesel fuel injection products in the first six months this year as compared to last year.

      Aircraft Engine Systems’ improvements reflect the favorable trends in commercial aviation. We experienced modest growth in commercial OEM sales, as Boeing and Airbus ramped up their production levels for narrow and widebody aircraft. Also, there has been increased demand for commercial aftermarket spare parts and repair and overhaul services.

      Cost of goods sold increased in both the three months and six months ended March 31, 2005, compared to the same periods last year, primarily as a result of increased sales. For the quarter, cost of goods sold represented 74.8% of sales this year and 75.2% last year. For the six months, cost of goods sold represented 75.2% of sales this year and 74.6% last year.

      Research and development increased in both the three months and six months ended March 31, 2005, as compared to the same periods last year. Research and development activities have continued at a pace similar to the last half of fiscal 2004, which totaled $21.3 million.

      Interest and other income increased in both the three months and six months ended March 31, 2005, compared to the same periods last year. Net gains on the sale of equipment were approximately $0.6 million in the most recent quarter, compared to net losses of $0.1 million in the same quarter a year ago. In addition, this year’s six month period was affected by the sale of rights to our aircraft propeller synchronizer product line to an unrelated third party, which resulted in a pre-tax gain of $3.8 million. Prior to the sale, the product line generated annual sales of approximately $2.0 million.

      Workforce management costs in the three months and six months ended March 31, 2005, are primarily related to the consolidation of manufacturing operations in The Netherlands and United Kingdom with existing operations in the United States and Germany. We are also consolidating a small manufacturing operation in Japan with an existing operation in China and are making sales force reductions in The Netherlands. These actions are discussed more fully in the Management Discussion and Analysis on pages 24-25 of our 2004 annual report to shareholders, which was filed with our Form 10-K/ A Amendment No. 1 for the year ended September 30, 2004.