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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

Commission file number 1-6263

AAR CORP.
(Exact name of Registrant as specified in its charter)

One AAR Place, 1100 N. Wood Dale Road, Wood Dale, Illinois 60191
(Address of principal executive offices, including zip code)

Registrant's telephone number, including area code: (630) 227-2000

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

        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 ý No o

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

        Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes ý No o

        At November 28, 2003, the aggregate market value of the Registrant's voting stock held by nonaffiliates was approximately $301,972,993 (based upon the closing price of the Common Stock at November 28, 2003 as reported on the New York Stock Exchange). The calculation of such market value has been made for the purposes of this report only and should not be considered as an admission or conclusion by the Registrant that any person is in fact an affiliate of the Registrant.

        On July 1, 2004, there were 32,243,868 shares of Common Stock outstanding.

Documents Incorporated by Reference

        Portions of the definitive proxy statement relating to the Registrant's 2004 Annual Meeting of Stockholders, to be held October 13, 2004, are incorporated by reference in Part III to the extent described therein.

TABLE OF CONTENTS

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PART I

ITEM 1.    BUSINESS (Dollars in thousands)

General

        AAR CORP. and its subsidiaries are referred to herein collectively as "AAR," "Company," "we," "us," and "our" unless the context indicates otherwise. We were founded in 1951, organized in 1955 and were reincorporated in Delaware in 1966. We are a leading independent provider of products and services to the worldwide aviation/aerospace industry. We also market and sell certain of our products and services to the U.S. Government, including various branches and agencies within the U.S. Military and their contractors. We conduct our business activities primarily through five principal operating subsidiaries: AAR Parts Trading, Inc., AAR Aircraft & Engine Sales & Leasing, Inc., AAR Services, Inc., AAR Manufacturing, Inc., and AAR International, Inc. Our international business activities are conducted primarily through AAR International, Inc.

        We report our activities in four business segments: (i) Inventory and Logistic Services, comprised primarily of business activities conducted through AAR Parts Trading, Inc. and AAR Services, Inc., (ii) Maintenance, Repair and Overhaul, comprised primarily of business activities conducted through AAR Engine Services, Inc. and AAR Allen Services, Inc., wholly-owned subsidiaries of AAR Parts Trading, Inc. and AAR Services, Inc., respectively, and AAR International, Inc., (iii) Manufacturing, comprised primarily of business activities conducted through AAR Manufacturing, Inc., and (iv) Aircraft and Engine Sales and Leasing, comprised of business activities primarily conducted through AAR Aircraft & Engine Sales & Leasing, Inc.

Inventory and Logistic Services

        Activities in our Inventory and Logistic Services segment include the purchase and sale of a wide variety of new, overhauled and repaired engine and airframe parts and components for the aviation aftermarket and military customers. We also provide customized inventory supply and management programs for engine and airframe parts and components in support of customer maintenance activities. We are an authorized distributor for more than 125 leading aviation and aerospace product manufacturers. We acquire aviation products for the Inventory and Logistic Services segment from domestic and foreign airlines, independent aviation service companies, aircraft leasing companies and original equipment manufacturers. In the Inventory and Logistic Services segment, the majority of our sales are made pursuant to standard commercial purchase orders. In certain inventory supply and management programs, we supply products and services under agreements reflecting negotiated terms and conditions.

Maintenance, Repair and Overhaul

        Activities in our Maintenance, Repair and Overhaul segment include the maintenance, repair and overhaul and exchange of a wide variety of airframe and engine parts and components for our commercial and military customers. Repair and overhaul capabilities include most commercial aircraft landing gear, a wide variety of avionics, instruments, electrical, electronic, fuel, hydraulic and pneumatic components and a broad range of internal airframe components. We also operate an aircraft maintenance facility providing airframe maintenance, modification, special equipment installation, painting services and aircraft terminal services for various models of commercial, military, regional, business and general aviation aircraft. We also operate an aircraft storage facility. In June 2004, we entered into a long-term lease to occupy a portion of an airframe maintenance facility in Indianapolis, Indiana, significantly expanding our maintenance and repair capacity and capabilities. The repair and overhaul of parts and components also support inventory management activities within the Inventory and Logistic Services segment. We also provide turbine engine overhaul and parts supply services to industrial gas and steam turbine operators. In this segment, in addition to sales made under standard commercial purchase orders, a portion of the segment's sales occur

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pursuant to contracts under which we agree to maintain, repair and overhaul parts, components and whole aircraft. In this segment, we purchase replacement parts from original equipment manufacturers and suppliers that are used in various maintenance, repair and overhaul operations. We have ongoing arrangements with original equipment manufacturers (OEM) that provide us access to parts, repair manuals and service bulletins in support of parts manufactured by the OEM. Although the terms of each arrangement vary, they typically are made on standard OEM terms as to duration, price and delivery. When possible, we will obtain replacement parts used in repair and overhaul activities from operating units in our Inventory and Logistic Services segment.

Manufacturing

        Activities in our Manufacturing segment include the manufacture and repair of a wide array of containers, pallets and shelters in support of military and humanitarian tactical deployment activities. We also design, manufacture and install in-plane cargo loading and handling systems for commercial and military aircraft and helicopters. We also design and manufacture advanced composite materials for commercial, business and military aircraft as well as advanced composite structures for the transportation industry. In this segment, sales are made to customers pursuant to standard commercial purchase orders and contracts. In this segment, we purchase aluminum sheets, extrusions and castings and other necessary supplies from a number of vendors.

Aircraft and Engine Sales and Leasing

        Activities in our Aircraft and Engine Sales and Leasing segment include the sale or lease of used commercial jet aircraft and the sale or lease of a wide variety of new and overhauled commercial jet engines. In this segment, each sale or lease is negotiated as a separate agreement which includes term, price, representations, warranties and lease return provisions. Leases are fixed in regard to term; early termination by the lessee is not permitted except in the event of a breach by us. In this segment, we purchase aircraft and engines from domestic and foreign airlines, aircraft and engine leasing companies and original equipment manufacturers. Activities in the Aircraft and Engine Sales and Leasing segment also include the formation and operation of joint ventures with strategic and financial partners. The primary business of these joint ventures is the ownership and lease of aircraft to commercial airlines. Within this segment, we also provide advisory services which consist of assistance in remarketing aircraft and engines, records management and storage maintenance.

Raw Materials

        We historically have been able to obtain raw materials and other items for our inventories for each of our segments at competitive prices, terms and conditions from numerous sources, and we expect to be able to continue to do so.

Terms of Sale

        In the Inventory and Logistic Services, Maintenance, Repair and Overhaul and Manufacturing segments, we generally sell our products under standard 30-day terms. On occasion, certain customers (principally foreign customers) will negotiate extended payment terms (60-90 days). Except for customary warranty provisions, customers do not have the right to return products nor do they have the right to extended financing. In the Aircraft and Engine Sales and Leasing segment, we sell our products on a cash due at delivery basis, standard 30-day terms or on an extended term basis.

Customers

        For each of our reportable segments, we furnish aviation products and services primarily through our own employees. The principal customers for our products and services in the Inventory and Logistic

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Services and Maintenance, Repair and Overhaul segments are domestic and foreign commercial airlines, regional and commuter airlines, business and general aviation operators, aviation original equipment manufacturers, aircraft leasing companies, domestic and foreign military organizations and independent aviation support companies. In the Manufacturing segment, our principal customers include domestic and foreign military organizations, domestic and foreign commercial airlines, aviation original equipment manufacturers and other industrial entities. The principal customers in the Aircraft and Engine Sales and Leasing segment include domestic and foreign commercial airlines and aircraft and engine finance and leasing companies. Sales of aviation products and services to commercial airlines are generally affected by such factors as the number, type and average age of aircraft in service, the levels of aircraft utilization (e.g., frequency of schedules), the number of airline operators and the level of sales of new and used aircraft.

Licenses

        We have 14 Federal Aviation Administration (FAA) licensed repair stations in the United States and Europe. Of the 14 FAA repair stations, eight are also Joint Aviation Authorities (JAA) licensed repair stations. Such licenses, which are ongoing in duration, are required in order for us to perform authorized maintenance, repair and overhaul services for our customers and are subject to revocation by the government for non-compliance with applicable regulations. Of the 14 FAA licensed repair stations, one is held in the Inventory and Logistic Services segment, nine are held in the Maintenance, Repair and Overhaul segment, and four are held in the Manufacturing segment. Of the eight JAA licensed repair stations, seven are held in the Maintenance, Repair and Overhaul segment and one is held in the Manufacturing segment. We believe that we possess all licenses and certifications that are material to the conduct of our business.

Competition

        Competition in the worldwide aviation/aerospace industry is based on quality, ability to provide a broad range of products and services, speed of delivery and price. Competitors in both the Inventory and Logistic Services and the Maintenance, Repair and Overhaul segments include original equipment manufacturers, the service divisions of large commercial airlines and other independent suppliers of parts and services. In our Aircraft and Engine Sales and Leasing segment, we face competition from financial institutions, syndicators, commercial and specialized leasing companies and other entities that provide financing. Our pallet, container and shelter manufacturing activities in our Manufacturing segment compete with several large and small companies, and our cargo systems competitors include a number of divisions of large corporations. Although certain of our competitors have substantially greater financial and other resources than we do, in each of our four reportable segments we believe that we have maintained a satisfactory competitive position through our responsiveness to customer needs, our attention to quality and our unique combination of market expertise and technical and financial capabilities.

Backlog

        At May 31, 2004, backlog believed to be firm was approximately $162,400 compared to $102,700 at May 31, 2003. Approximately $148,200 of this backlog is expected to be filled within the next 12 months. The increase in our backlog reflects orders in our Manufacturing segment for products that support the U.S. Military's rapid deployment needs and cargo systems.

Employees

        At May 31, 2004, we employed approximately 2,300 persons worldwide.

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Sales to U.S. Government

        Sales to the U.S. Government, its agencies and its contractors were $222,558 (34.1% of total sales), $170,191 (28.1% of total sales), and $163,173 (25.5% of total sales) in fiscal years 2004, 2003 and 2002, respectively. Because such sales are subject to competitive bidding and government funding, no assurance can be given that such sales will continue at levels previously experienced. The majority of our government contracts are for aviation products and services used for ongoing routine military logistic support activities; unlike weapons systems and other high-technology military requirements, these products and services are less likely to be affected by significant changes in defense spending. Our government contracts are subject to termination at the election of the government; in the event of such a termination we would be entitled to recover from the government all allowable costs incurred by us through the date of termination.

Additional Information

        For additional information concerning our business segments, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business Segment Information" in Note 13 of Notes to Consolidated Financial Statements.

        Our internet address is www.aarcorp.com. We make available free of charge through our web site our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish such material to the SEC. Information contained on our web site is not a part of this report.

ITEM 2.    PROPERTIES

        Our principal activities in the Aircraft and Engine Sales and Leasing and Inventory and Logistic Services segments are conducted from a building owned by us in Wood Dale, Illinois, subject to a mortgage. In addition to warehouse space, this facility includes executive, sales and administrative offices. We also lease facilities in Atlanta and Macon, Georgia and Jacksonville, Florida to support activities in the Inventory and Logistic Services segment.

        Maintenance, Repair and Overhaul activities are conducted in buildings owned by us located in Frankfort, New York; Windsor, Connecticut (subject to an industrial revenue bond) and near Schiphol International Airport in The Netherlands. This segment also conducts overhaul and repair activities in buildings leased by the Company in Miami, Florida; Garden City, New York; London, England; Roswell, New Mexico; and Oklahoma City, Oklahoma. In June 2004, we agreed to lease a portion of an aircraft maintenance facility in Indianapolis, Indiana.

        Our activities in the Manufacturing segment are conducted at facilities owned by us in Clearwater, Florida (subject to an industrial revenue bond) and Cadillac and Livonia, Michigan.

        We believe that our owned and leased facilities are suitable and adequate for our operational requirements.

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ITEM 3.    LEGAL PROCEEDINGS (Dollars in thousands)

        Except as described below, we are not a party to any material, pending legal proceeding (including any governmental or environmental proceedings) other than routine litigation incidental to our existing business.

        AAR Manufacturing, Inc., a subsidiary of the Company ("subsidiary") received an Administrative Order for Response Activity ("Order") dated August 7, 2003, from the Michigan Department of Environmental Quality ("MDEQ") relating to environmental conditions at and in the vicinity of our subsidiary's Cadillac, Michigan plant. The Order requires our subsidiary to perform environmental investigatory work, prepare a feasibility study and a remedial action plan, and perform interim response actions. The interim response actions include continuation of the response activities our subsidiary is performing under a 1985 Consent Decree, operation of a soil vapor extraction system our subsidiary had previously installed and operated, determination of the need to provide alternate water supplies to off-site properties (and if it is so determined then to actually provide it), removal of any free phase liquids encountered in the ground, providing notices of groundwater contamination migration to off-site property owners, and other actions determined by the MDEQ or our subsidiary to be appropriate. A letter dated June 14, 2002 from the MDEQ further demands payment of environmental response costs already incurred by the MDEQ in the amount of $525 plus interest plus unspecified costs to be incurred in the future by the MDEQ. The Order and the letter which accompanies the Order threaten the imposition of civil fines up to $25 for each day of violation of the Order plus exemplary damages up to three times the costs incurred by the MDEQ if our subsidiary does not comply with the Order. The Order may require the implementation of the remedial action plan although it is not clear on that point. The Order requires the implementation of emergency response action if a release of hazardous substances, threat of a release, or exacerbation of existing contamination occurs during the pendency of the Order.

        Our subsidiary advised the MDEQ that it will perform the requirements of the Order to the extent those requirements apply to the allegation by the MDEQ that a release of hazardous substances occurred after the execution of the 1985 Consent Decree. Our subsidiary declined to perform work required under the Order which our subsidiary believes is based on claims resolved in the 1985 Consent Decree. The MDEQ responded to our subsidiary by saying that the MDEQ "will be taking appropriate action to protect public health, safety and welfare and the environment, and gain AAR's compliance with Part 201."

        Our subsidiary has spent approximately $100 in performing environmental investigations under the Order. Our subsidiary may conduct work under the Order in addition to the work to be performed noted above. We believe the work performed by our subsidiary since the issuance of the Order supports the positions previously taken by our subsidiary regarding the movement of groundwater in the vicinity of our subsidiary's plant and the ongoing capture of groundwater for treatment by our subsidiary. However, there continues to be disagreement between our subsidiary and the MDEQ concerning the conclusions to be drawn from the data from that work. No action has been taken by the MDEQ to enforce the Order against our subsidiary, although the MDEQ has retained contractors to perform environmental investigations in the vicinity of our subsidiary's plant.

ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

        No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

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Supplemental Item:

EXECUTIVE OFFICERS OF THE REGISTRANT

        Information concerning each of our executive officers is set forth below:

        Mr. Storch has served as President of the Company since 1989 and Chief Executive Officer since 1996. Previously, he served as Chief Operating Officer from 1989 to 1996 and as a Vice President of the Company from 1988 to 1989. Mr. Storch joined the Company in 1979 and served as president of a major subsidiary from 1984 to 1988. Mr. Storch has been a director of the Company since 1989. Mr. Storch is Ira A. Eichner's son-in-law. Mr. Eichner is Chairman of the Board and a Director of the Company.

        Mr. Pulsifer has served as Vice President, General Counsel and Secretary of the Company since 1990. Previously, he served as Vice President (since 1990) and General Counsel (since 1987). He was previously with United Airlines, Inc. for 14 years, most recently as Senior Counsel.

        Mr. Romenesko has served as Vice President and Chief Financial Officer since 1994. Previously, he served as Controller of the Company from 1991 to 1995 and in various other positions since joining the Company in 1981.

        Mr. Clark has served as Group Vice President, Maintenance, Repair and Overhaul since 2000. Previously, he was General Manager of AAR Aircraft Component Services—Amsterdam from 1995 to 2000 and in various other positions since joining the Company in 1982.

        Mr. McDonald has served as Group Vice President, Manufacturing since 2003. Previously, he served as General Manager of AAR Mobility Systems from 2000 to 2003 and as Vice President of Operations from 1996 to 2003. He was previously with General Electric in various positions from 1984 to 1996.

        Each executive officer is elected annually by the Board of Directors at the first meeting of the Board held after the annual meeting of stockholders. Executive officers continue to hold office until their successors are duly elected or until their death, resignation, termination or reassignment.

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PART II

ITEM 5.    MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
(Dollars in thousands, except per share amounts)

        Our Common Stock is traded on the New York Stock Exchange and the Chicago Stock Exchange. On July 1, 2004 there were approximately 7,000 holders of Common Stock, including participants in security position listings.

        Certain of our financing arrangements contain provisions restricting the payment of dividends or repurchase of our shares. See Note 3 of Notes to Consolidated Financial Statements included herein. Under the most restrictive of these provisions, we may not pay dividends (other than stock dividends) or acquire our capital stock if, after giving effect to the aggregate amounts paid on or after June 1, 1995, such amounts exceed the sum of $20,000 plus 50% of Consolidated Net Income (Loss) after June 1, 1994. We are currently prohibited from paying dividends or purchasing our shares pursuant to this provision, and during fiscal 2004 and 2003 we did not purchase any of our equity securities.

        The table below sets forth for each quarter of the fiscal year indicated the reported high and low market prices of our Common Stock on the New York Stock Exchange and the quarterly dividends declared. We suspended payment of dividends in October 2002.

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ITEM 6.    SELECTED FINANCIAL DATA
(In thousands, except per share amounts)

Notes:

¹

In connection with certain long-term inventory management programs, we purchased factory-new products on behalf of our customers from original equipment manufacturers. These products were purchased from the manufacturer and "passed through" to our customers at our cost. In December 2000, these inventory management programs were discontinued.

²

See Note 2 of notes to our consolidated financial statements for a discussion regarding impairment and special charges recorded during fiscal 2003 and fiscal 2002.

³

In February 2002, we sold 5,010 shares of common stock for $34,334, net of expenses.

⁴

In February 2004, we sold $75,000 of 2.875% convertible notes due February 1, 2024.

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ITEM 7.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands)

General Overview

        We report our activities in four business segments: Inventory and Logistic Services; Maintenance, Repair and Overhaul; Manufacturing; and Aircraft and Engine Sales and Leasing.

        Sales in the Inventory and Logistic Services segment are derived from the sale of a wide variety of new, overhauled and repaired engine and airframe parts and components to the commercial aviation and military markets, as well as the distribution of new airframe parts purchased from various original equipment manufacturers and sold to commercial and general aviation customers. Cost of sales consists principally of the cost of product (primarily aircraft and engine parts) and overhead (primarily indirect labor, facility cost and insurance).

        Sales in the Maintenance, Repair and Overhaul segment are derived from the repair and overhaul of a wide range of commercial and military aircraft engine and airframe parts, landing gear and components; aircraft maintenance and storage; and the repair, overhaul and sale of parts for industrial gas and steam turbine operators. Cost of sales consists principally of cost of product (primarily replacement aircraft parts), direct labor and overhead.

        Sales in the Manufacturing segment are derived from the manufacture and sale of a wide array of containers, pallets and shelters used to support the U.S. Military's tactical deployment requirements, in-plane cargo loading and handling systems for commercial and military applications and advanced composite materials and components for aerospace and industrial use. Cost of sales consists principally of the cost of product, direct labor and overhead.

        Sales in the Aircraft and Engine Sales and Leasing segment are derived from the sale and lease of commercial aircraft and engines and technical and advisory services. Cost of sales consists principally of cost of product (aircraft and engines), labor and the cost of lease revenue (primarily depreciation, lease expense and insurance).

        The table below sets forth consolidated sales for our four business segments for each of the last three fiscal years ended May 31.

        As a result of the events of September 11, 2001, which occurred at a time when the worldwide commercial airline environment was already under significant pressure principally due to an economic downturn, most of the major U.S. based commercial airlines announced substantial reductions in capacity, some in excess of 20%. Commercial airlines accelerated their older generation aircraft fleet retirement plans. The reduction in industry-capacity and the financial impact of the events of September 11, 2001 on our customers had a significant negative effect on our fiscal 2002 sales and operating results as demand declined for our products and services within the Inventory and Logistic Services, Maintenance, Repair and Overhaul and Aircraft and Engine Sales and Leasing segments.

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        During fiscal 2003, airline traffic began to strengthen and it appeared that the beginning of the airline industry recovery was underway. However, during the third quarter of fiscal 2003, demand for products and services from many of our airline customers weakened as a result of the war in Iraq and the outbreak of Severe Acute Respiratory Syndrome (SARS). During fiscal 2003, sales of products and services to the U.S. Government, its agencies and its contractors increased primarily due to increased U.S. Military activity.

        During fiscal 2004, sales of our manufactured products and performance-based logistics and supply chain management services continued to increase as a result of the U.S. Military's buildup and increased demand for supply chain management services. Although it is very difficult for us to predict the extent and duration of the military buildup and its impact on our near-term results, we believe that we are well positioned with our current products and services and growth plans to benefit from longer-term U.S. Military deployment and program-management strategies. Total sales to the U.S. Government and its contractors for fiscal 2004 were $222,558, an increase of 30.8% compared to fiscal 2003, and represented 34.1% of fiscal 2004 consolidated sales.

        During fiscal 2004, there have been positive signs the airline industry is improving, such as year-over-year improvement in available seat miles, revenue passenger miles and load factors. However, rising fuel prices and high labor costs continue to threaten the commercial airline industry, and recently certain major U.S. carriers warned they may be forced to file for bankruptcy protection. Low cost carriers with little or no infrastructure to support their maintenance requirements have gained market share from the major U.S. carriers. Certain of these low cost carriers are flying newer aircraft which will generate demand for maintenance in future years. We anticipate a fundamental shift in the way our airline customers manage their business, including intensified focus on cost control and increased use of third-party maintenance providers. We believe we are well positioned with our broad range of products and services as these trends develop.

Factors Which May Affect Future Results

        Our operating results and financial position may be adversely affected or fluctuate on a quarterly basis as a result of general economic conditions, geo-political events, the commercial airline environment and other factors, including: (1) declining demand for our products and services and the ability of our customers to meet their financial obligations; (2) declining market values for aviation products and equipment; (3) difficulties in re-leasing or selling aircraft and engines that are currently being leased; (4) lack of assurance that sales to the U.S. Government, its agencies and its contractors (which were 34.1% of total sales in fiscal 2004), will continue at levels previously experienced; (5) access to the debt and equity capital markets and the ability to draw down funds under financing agreements; (6) non-compliance with restrictive and financial covenants contained in certain of our loan agreements; (7) changes in or non-compliance with laws and regulations that may affect certain of our aviation related activities that are subject to licensing, certification and other regulatory requirements imposed by the FAA and other regulatory agencies, both domestic and foreign; (8) competition from other companies, including original equipment manufacturers, some of which have greater financial resources than us; (9) exposure to product liability and property claims that may be in excess of our substantial liability insurance coverage; and (10) the outcome of any pending or future material litigation or environmental proceedings.

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Results of Operations

Fiscal 2004 Compared with Fiscal 2003

        Consolidated sales for fiscal 2004 were $651,958, which represents an increase of $45,621 or 7.5% compared to fiscal 2003.

        In the Inventory and Logistic Services segment, fiscal 2004 sales increased $7,927 or 3.2% compared to fiscal 2003. The increase in sales compared to the prior year is primarily attributable to higher sales to the U.S. Military and its contractors for spares and logistics support and increased sales of engine parts. In the Inventory and Logistic Services segment, we experienced lower sales of parts to general aviation customers as a result of our strategic decision to de-emphasize certain lower margin products. Going forward, we will continue our strategy of focusing on the distribution of higher margin products.

        In the Maintenance, Repair and Overhaul segment, fiscal 2004 sales increased $10,817 or 5.3% compared with fiscal 2003. The increase in sales compared to the prior year is primarily attributable to higher sales at our aircraft maintenance facility due to an increase in the number of long-term maintenance contracts with certain customers. At certain of our component repair facilities, demand for component repair from our commercial airline customers has not recovered, and as a result we experienced lower sales compared to the prior year.

        In the Manufacturing segment, fiscal 2004 sales increased $31,439 or 26.2% compared to fiscal 2003. The increase in sales compared to the prior year is due to record shipments of our manufactured products which support the U.S. Military tactical deployment activities. In the Manufacturing segment, we experienced lower sales of our non-aviation composite structure products as a result of the completion of a major contract in May 2003.

        In the Aircraft and Engine Sales and Leasing segment, fiscal 2004 sales decreased $4,562 or 13.1%. Sales in this segment remain at historically low levels.

        Consolidated gross profit increased $23,649 or 30.7% compared with the prior year. The increase in our consolidated gross profit is primarily due to the increase in sales and an increase in our consolidated gross profit margin to 15.4% from 12.7% in the prior year. During the fourth quarter of fiscal 2004, we wrote off an investment in a joint venture (see Note 11) and the associated $1,269 pre-tax charge was recorded in Cost of Sales on the Consolidated Statement of Operations. The gross margin percentage increased in the Inventory and Logistic Services segment primarily due to the mix of inventories sold and in the Manufacturing segment primarily due to increased volume at our facilities that manufacture products supporting the U.S. Military's tactical deployment activities. Fiscal 2003 gross profit included the $5,360 impairment reserve recorded in May 2003.

        Operating income increased $20,565 compared with the prior year primarily due to the increase in gross profit. During fiscal 2004, our selling, general, administrative and other expenses increased by $3,084 compared with fiscal 2003 primarily as a result of a provision for an unfavorable judgement in the amount of $1,600, a provision for a customer allowance of $1,335 and slightly higher personnel costs, partially offset by a $836 gain recorded from the sale of a facility located in Holtsville, New York. Interest expense decreased $720 compared to the prior year primarily due to decreased average borrowings.

        During the third quarter of fiscal 2004, upon completion of our fiscal 2003 Federal income tax return, we determined that we qualified for additional tax benefits of $604 related primarily to higher than estimated margin on export activities. This benefit was recorded in the third quarter. In addition, our effective tax rate for fiscal 2004 reflects increased expected tax benefits related to current year export activities. As a result of these items, we recorded a tax benefit of $1,797 for the fiscal year ended May 31, 2004.

        As a result of the factors discussed above, we reported net income of $3,504 for fiscal 2004.

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Fiscal 2003 Compared with Fiscal 2002

        Consolidated sales for fiscal 2003 were $606,337, which represents a decrease of $32,384 or 5.1% compared to fiscal 2002.

        In the Inventory and Logistic Services segment, fiscal 2003 sales declined $12,036 or 4.7% compared to fiscal 2002. The decrease in sales compared to the prior year was attributable to a $16,660 reduction in sales to general aviation customers as a result of management's decision to reduce its investment in the low-margin general aviation market by eliminating most general aviation branch locations and reducing staff levels. In the Inventory and Logistics Services segment, we experienced increased sales to the U.S. Military for spares and logistics support and higher sales of serviceable parts to certain program customers.

        In the Maintenance, Repair and Overhaul segment, fiscal 2003 sales declined $11,061 or 5.1% compared to fiscal 2002. The decrease in sales compared to the prior year was attributable to lower sales in the U.S., partially offset by increased component overhaul sales in Europe primarily due to favorable changes in currency translation rates.

        In the Manufacturing segment, fiscal 2003 sales increased $20,313 or 20.4% as we experienced record demand for our manufactured products which support the U.S. Military deployment activities. Increased shipments of our non-aviation related composite structure products also contributed to higher sales within this segment.

        In the Aircraft and Engine Sales and Leasing segment, fiscal 2003 sales declined $29,600 or 46.0%. Sales in this segment are principally comprised of lease revenues from aircraft and engines on lease to operators, as well as sales of aircraft and engines. Sales in this segment remain historically low, reflecting the lack of sales activity caused by the aviation industry-wide reduction in demand for capital assets post September 11, 2001.

        During the fourth quarter of fiscal 2003, we recorded impairment charges related to certain engine and airframe parts and whole engines in the amount of $5,360. The fiscal 2003 impairment charge was based upon an updated assessment of the net realizable values for certain engine and airframe parts and future undiscounted cash flows for whole engines. Of the $5,360 impairment charge recorded during fiscal 2003, $2,360 was related to the Inventory and Logistic Services segment, and $3,000 related to the Aircraft and Engine Sales and Leasing segment.

        Consolidated gross profit, before consideration of impairment charges in fiscal 2003 and 2002, decreased $7,330 or 8.2% as a result of lower sales and a reduction in the consolidated gross profit margin from 14.1% in fiscal 2002 to 13.6% in fiscal 2003. The reduction in the consolidated gross profit margin was primarily attributable to lower margins experienced in the Maintenance, Repair and Overhaul segment, as well as lower volume through most of the facilities within that segment, partially offset by an increase in the gross profit margin in the Manufacturing segment due principally to increased volume and the mix of products sold. Including the effect of the impairment charges recorded in fiscal 2003 and 2002, consolidated gross profit increased $63,210.

        Operating income, before consideration of impairment and other special charges, decreased $1,138 as a result of lower sales and a reduction in the consolidated gross profit margin, partially offset by lower selling, general and administrative expenses. During fiscal 2003, we reduced our selling, general and administrative expenses by $6,192 or 7.3% principally as a result of lower personnel costs and reduced discretionary spending. Interest expense decreased $259 compared to the prior year principally due to decreased average borrowings during fiscal 2003. Interest income decreased $1,022 over the prior year due to a decline in average cash invested during the fiscal year and lower interest rates.

        Our effective tax benefit rate for fiscal 2003 was 36.3% compared to 40.0% in fiscal 2002. The fiscal 2002 income tax benefit includes a $2,000 reduction in income tax expense representing the reversal of federal income tax liabilities. This adjustment reduced federal and state income tax expense primarily

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recorded during the fiscal years 1999 through 2001, related to incentives on exports and tax credits. A change in tax law effective in fiscal 2002 regarding the computation of export incentives, combined with previous experience with tax examinations, resulted in the reduction in the tax expense.

        We recorded a net loss of $12,410 during fiscal 2003 due to the factors discussed above.

Liquidity and Capital Resources

        Historically, we have funded our operating activities and met our commitments through the generation of cash from operations, augmented by the periodic issuance of common stock and debt in the public and private markets. In addition to these cash sources, we also rely on secured credit arrangements, which currently include an accounts receivable securitization program and a secured revolving credit facility. Our continuing ability to borrow from our lenders and issue debt and equity securities to the public and private markets in the future may be negatively affected by a number of factors, including general economic conditions, airline and aviation industry conditions, geo-political events, including the war on terrorism, and our operating performance. Our ability to use our accounts receivable securitization program and revolving credit facility is also dependent on these factors. Our ability to generate cash from operations is influenced primarily by our operating performance and working capital management. We also have a universal shelf registration on file with the Securities and Exchange Commission under which, subject to market conditions, up to $163,675 of common stock, preferred stock or medium- or long-term debt securities may be issued or sold.

        At May 31, 2004, our liquidity and capital resources included cash of $41,010 and working capital of $300,943. As of May 31, 2004, $7,313 of cash was restricted to support letters of credit. At May 31, 2004, we had $35,000 available under our accounts receivable securitization program; no accounts receivable were securitized as of that date. The amount available under this agreement is based on a formula of qualifying accounts receivable. At May 31, 2004, we had $22,449 available under our secured revolving credit facility; no amounts were outstanding as of that date. The amount available under the revolving credit facility is also based on a formula of qualifying assets. As of May 31, 2004, unrestricted cash and amounts available to us under our secured credit arrangement and accounts receivable securitization program totaled $91,146.

        On February 3, 2004, we issued $75,000 principal amount of 2.875% convertible notes due February 1, 2024. We used a portion of the proceeds to repurchase $35,000 of accounts receivable which had been sold under our accounts receivable securitization facility, to repay $16,900 of 8.0% notes prior to their maturity, to repay $4,000 outstanding under our revolving credit facility, to retire $13,426 of notes payable due in June 2005 and to retire $3,500 of notes payable due in December 2007 (see Note 3).

        In January 2004, we refinanced non-recourse notes of $32,132 with the maturity date extended to July 2005. Accordingly, a portion of the non-recourse debt has been classified as long-term on the May 31, 2004 Consolidated Balance Sheet. As of May 31, 2004, our equity investment in the aircraft that secures the non-recourse debt was $2,085.

        On October 3, 2003, we entered into a sale-leaseback transaction whereby we sold and leased back a facility in Garden City, New York. Net proceeds from the sale were $13,991 and were used in part to reduce our outstanding borrowings (see Note 9).

        On July 1, 2003, we completed an $11,000 financing secured by a mortgage on our Wood Dale, Illinois facility. The term of the financing is five years utilizing a fifteen-year amortization with a LIBOR-based interest rate of no less than 6.25%.

        On April 18, 2003, Standard and Poor's downgraded the senior unsecured debt rating to BB minus from BBB minus with an outlook rating of negative. On July 2, 2004, Standard and Poor's upgraded our outlook rating from negative to stable. On July 18, 2003, Fitch Ratings downgraded the unsecured debt rating to BB minus from BB plus and revised the outlook rating to negative from stable. On August 5,

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2003, Moody's Investors Service downgraded our senior unsecured debt rating to B2 from B1. We were removed from credit watch following the downgrade actions by each of the respective rating agencies.

        We continue to evaluate financing arrangements on commercially reasonable terms that will allow us to improve our liquidity position and finance future growth. Our ability to obtain additional financing is dependent upon a number of factors, including the geo-political environment, general economic conditions, airline industry conditions, our operating performance and market conditions in the public and private debt and equity markets.

        During the twelve-month period ended May 31, 2004, we generated $14,572 of cash from operations primarily due to a reduction in inventories of $15,602 and $26,680 of non-cash depreciation and amortization. However, accounts and trade notes receivables increased $41,374 as a result of an increase in sales and the repurchase for cash of $26,800 of accounts receivable which had been sold under our accounts receivable securitization facility.

        During the twelve-month period ended May 31, 2004, cash provided from investing activities was $5,626 consisting primarily of proceeds from the sale and leaseback of our Garden City, New York facility in the amount of $13,991 and proceeds from the sale of the Holtsville, New York facility in the amount of $2,931, partially offset by capital expenditures of $10,286. We expect fiscal 2005 capital expenditures to be $13,000 to $15,000, reflecting increased investments in airframe maintenance and higher-margin manufacturing capabilities.

        During the twelve-month period ended May 31, 2004, our financing activities used $8,373 of cash. Proceeds from borrowings during fiscal 2004 were $89,701, which included the issuance of $75,000 of 2.875% convertible notes and $11,000 of financing secured by a mortgage on the Wood Dale, Illinois facility, as well as proceeds from other borrowings of $3,701. Reductions in borrowings during fiscal 2004 were $94,615. During the twelve-month period ended May 31, 2004, we retired 7¹/4% Notes in the amount of $22,600 which matured on October, 15, 2003, repaid $24,000 outstanding under the Merrill Lynch secured credit facility, repaid $16,900 of 8.0% notes prior to their maturity, retired $21,291 of notes payable due in June 2005, retired $5,630 of notes payable due in December 2007 and reduced other borrowings by $4,194.

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Contractual Obligations and Off-Balance Sheet Arrangements

        A summary of contractual obligations and off-balance sheet arrangements as of May 31, 2004 is as follows:

        We routinely issue letters of credit and performance bonds in the ordinary course of business. These instruments are typically issued in conjunction with insurance contracts or other business requirements. The total of these instruments outstanding at May 31, 2004 was approximately $10,952.

Critical Accounting Policies and Significant Estimates

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

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

        Inventories    Inventories are valued at the lower of cost or market. Cost is determined by the specific identification, average cost or first-in, first-out methods. Provisions are made for excess and obsolete inventories and inventories that have been impaired as a result of industry conditions. We have utilized certain assumptions when determining the market value of inventories, such as historical sales of inventory, current and expected future aviation usage trends, replacement values and expected future demand. Principally as a result of the terrorist attacks of September 11, 2001 and its anticipated impact on the global airline industry's financial condition, fleet size and aircraft utilization, we recorded a significant charge for impaired inventories during the second quarter of fiscal 2002 utilizing those assumptions. During the fourth quarter of fiscal 2003, we recorded an additional charge as a result of a further decline in market value for these inventories. Reductions in demand for certain of our inventories or declining market

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values, as well as differences between actual results and the assumptions utilized by us when determining the market value of our inventories, could result in additional impairment charges in future periods.

        Equipment on or Available for Lease    Lease revenue is recognized as earned. The cost of the asset 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. The balance sheet classification is based on the lease term, with fixed-term leases less than twelve months classified as short-term and all others classified as long-term.

        In accordance with Statement of Financial Accounting Standards No. 144 (SFAS No. 144), "Accounting for the Impairment or Disposal of Long-lived Assets", we are required to test for impairment of long-lived assets whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable from its undiscounted cash flows. When applying the provisions of SFAS No. 144 to equipment on or available for lease, we have utilized certain assumptions when estimating 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 equipment on or available for lease.

        Aviation Equipment Operating Leases    From time to time we lease aviation equipment (engines and aircraft) from lessors under arrangements that are classified by us as operating leases. We may also sublease the aviation equipment to a customer on a short- or long-term basis. The terms of the operating leases in which we are the lessee are one year with options to renew annually at our election. If we elect not to renew a lease or the lease term expires, we will purchase the equipment from the lessor at its scheduled purchase option price. The terms of the lease agreements also allow us to purchase the equipment at any time during a lease at its scheduled purchase option price. In those instances in which we anticipate that we will purchase aviation equipment and that the scheduled purchase option price will exceed estimated undiscounted cash flows related to the equipment, we record an accrual for loss. We have utilized certain assumptions when estimating future undiscounted cash flows, such as current and future lease rates, 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 provisions for losses on aviation equipment under operating leases.

Forward-Looking Statements

        Management's Discussion and Analysis of Financial Condition and Results of Operations contains certain statements relating to future results, which are forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on the beliefs of management, as well as assumptions and estimates based on information available to us 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 this Item 7 entitled "Factors Which May Affect Future Results". 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 our control. We assume no obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

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ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(Dollars in thousands)

        Our exposure to market risk includes fluctuating interest rates under our credit agreements, foreign exchange rates and accounts receivable. See Part II, Item 8 for a discussion on accounts receivable exposure. During fiscal 2004 and 2003, we did not utilize derivative financial instruments to offset these risks.

        At May 31, 2004, $22,449 was available under our secured revolving credit facility with Merrill Lynch Capital. Interest on amounts borrowed under this credit facility is LIBOR based. As of May 31, 2004, the outstanding balance under this agreement was $0. A hypothetical 10 percent increase to the average interest rate under the credit facilities applied to the average outstanding balance during fiscal 2004 would have reduced our pre-tax income by approximately $31 during fiscal 2004.

        Revenues and expenses of our foreign operations are translated at average exchange rates during the period, and balance sheet accounts are translated at period-end exchange rates. Balance sheet translation adjustments are excluded from the results of operations and are recorded in stockholders' equity as a component of accumulated other comprehensive income (loss). A hypothetical 10 percent devaluation of foreign currencies against the U.S. dollar would not have a material impact on our financial position or results of operations.

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ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm

TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF AAR CORP.:

        We have audited the accompanying consolidated balance sheets of AAR CORP. and subsidiaries as of May 31, 2004 and 2003 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended May 31, 2004. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AAR CORP. and subsidiaries as of May 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended May 31, 2004, in conformity with accounting principles generally accepted in the United States of America.

KPMG LLP

Chicago, Illinois
June 28, 2004

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AAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes to consolidated financial statements
are an integral part of these statements.

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AAR CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

ASSETS

The accompanying notes to consolidated financial statements
are an integral part of these statements.

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AAR CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

LIABILITIES AND STOCKHOLDERS' EQUITY

The accompanying notes to consolidated financial statements
are an integral part of these statements.

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AAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE THREE YEARS ENDED MAY 31, 2004

The accompanying notes to consolidated financial statements
are an integral part of these statements.

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AAR CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS