<PAGE>

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

                                  FORM 10-K/A

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934
          For the fiscal year ended May 31, 2000

[_]  TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934
     For the transition period from __________ to __________

                        Commission file number 0-26088

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
            (Exact name of registrant as specified in its charter)

     Washington                                  91-1744587
     (State or other jurisdiction of             (I.R.S. Employer
     incorporation or organization)              Identification No.)

     430 Olds Station Road, Third Floor
     Wenatchee, Washington                         98801
     (Address of principal executive offices)    (Zip Code)

     Registrant's telephone number, including area code: (509) 667-9600

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

     Title of each class      Name of each exchange on which registered
     -------------------      -----------------------------------------
             None                            None

          Securities registered pursuant to Section 12(g) of the Act:
                         Common Stock, $.001 par value
                               (Title of class)

                        Common Stock Purchase Warrants
                               (Title of class)

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 ___
                                      ---

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 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. [X]

State the aggregate market value of the voting stock held by non-affiliates,
based on the closing price for the registrant's Common Stock on the Nasdaq
National Market System, as of August 18, 2000: approximately $47,883,758.

Indicate the number of shares outstanding of each of the registrant's classes of
common equity, as of August 18, 2000: Common Stock, $.001 par value ("Common
Stock"): 34,261,160 shares.

Documents Incorporated by Reference: None, except certain Exhibits referred to
on the list of Exhibits, contained in Item 14 of this report.
<PAGE>

<TABLE>
<CAPTION>
                               TABLE OF CONTENTS
                               -----------------

Item of Form 10-K                                                                                  Page
-------------------------------------------------------------------------------------------------------
<S>                                                                                                <C>
PART I

   ITEM 1    Description of Business............................................................      1
   ITEM 2    Description of Property............................................................     28
   ITEM 3    Legal Proceedings..................................................................     29
   ITEM 4    Submission of Matters to a Vote of Security Holders................................     29

PART II

   ITEM 5    Market for Common Equity and Related Shareholder Matters...........................     30
   ITEM 6    Selected Financial Data............................................................     41
   ITEM 7    Management's Discussion and Analysis of Financial Condition and Results
             of Operations......................................................................     43
   ITEM 7A   Quantitative and Qualitative Disclosures About Market Risk.........................     53
   ITEM 8    Financial Statements...............................................................     54
   ITEM 9    Changes In and Disagreements with Accountants on Accounting and Financial
             Disclosure.........................................................................     91

PART III

   ITEM 10   Directors and Executive Officers of the Company....................................     92
   ITEM 11   Executive Compensation.............................................................     96
   ITEM 12   Security Ownership of Certain Beneficial Owners and Management.....................    101
   ITEM 13   Certain Relationships and Related Transactions.....................................    104
   ITEM 14   Exhibits, Financial Statement Schedules and Reports on Form 8-K....................    105

SIGNATURES......................................................................................    111
</TABLE>

                                      (i)
<PAGE>

                                    PART I

ITEM 1.  DESCRIPTION OF BUSINESS

Overview

Pacific Aerospace & Electronics, Inc. is an international engineering and
manufacturing company with operations in the United States and the United
Kingdom.  We design, manufacture and sell components and subassemblies used in
technically demanding environments.  Products that we produce primarily for the
aerospace and transportation industries include machined, cast, and formed metal
parts and subassemblies, using aluminum, titanium, magnesium, and other metals.
Products that we produce primarily for the defense, electronics,
telecommunications and medical industries include components such as
hermetically sealed electrical connectors and instrument packages, and ceramic
capacitors, filters and feedthroughs.  Our customers include global leaders in
all of these industries.  We are organized into three operational groups:  U.S.
Aerospace, U.S. Electronics, and European Aerospace.  Each of these groups is
composed of a number of operating divisions.

During the 2000 fiscal year, we acquired Skagit Engineering & Manufacturing,
Inc. ("Skagit") and NOVA-TECH Engineering, Inc. ("Nova-Tech").  We have combined
the operations of Skagit and Nova-Tech, and they now operate as the Engineering
& Fabrication Division of our U.S. Aerospace Group.  These acquisitions
significantly expanded our capabilities and opportunities in the areas of
engineering design and metal fabrication.  See " - Products, Processes and
Markets - U.S. Aerospace Group - Engineering & Fabrication Division."  In
addition, during the 2000 fiscal year, we formed the Applied Technology Division
of our U.S. Electronics Group.  This division was formed primarily to take
advantage of opportunities to apply our proprietary and patented technologies in
the fuel cell, telecommunications, and advanced medical products industries.

For our fiscal year ended May 31, 2000, we had net sales of approximately $113
million, with the European Aerospace Group contributing approximately $57
million in net sales.  On October 31, 2000, we announced our intention to sell
our European Aerospace Group in order to reduce our outstanding 11 1/4% senior
subordinated notes.  As of May 31, 2000, we had approximately $64 million in
principal amount of 11 1/4% senior subordinated notes outstanding.  Because we
have just begun the process of seeking buyers for our European Aerospace Group,
we do not know whether we will be successful in selling that group and, if
successful, we do not know the amount of net proceeds that would be available to
reduce our 11 1/4% senior subordinated notes.

References in this Form 10-K to the Company include Pacific Aerospace &
Electronics, Inc., and its subsidiaries.  Our headquarters are located at 430
Olds Station Road, Third Floor, Wenatchee, Washington 98801, and our telephone
number is (509) 667-9600.

                                       1
<PAGE>

Corporate History

We have acquired all but one of our divisions in a series of acquisitions since
1990.  We accounted for each of the acquisitions as a purchase.  The following
chart identifies as of May 31, 2000 our three operational groups, the operating
divisions that comprise those groups, the year of each acquisition, and the
locations of our operations.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
                                                    Year
                                                  Acquired                  Current Location
-----------------------------------------------------------------------------------------------------
<S>                                            <C>                        <C>
U.S. ELECTRONICS GROUP
-----------------------------------------------------------------------------------------------------
Interconnect Division                          1990 and 1998              Wenatchee, Washington
-----------------------------------------------------------------------------------------------------
Filter Division                                1995                       Wenatchee, Washington
-----------------------------------------------------------------------------------------------------
Bonded Metals Division                         1997                       Sequim, Washington
-----------------------------------------------------------------------------------------------------
Display Division                               1998                       Vancouver, Washington
-----------------------------------------------------------------------------------------------------
Applied Technology Division                    N/A *                      Wenatchee, Washington
-----------------------------------------------------------------------------------------------------

-----------------------------------------------------------------------------------------------------
U.S. AEROSPACE GROUP
-----------------------------------------------------------------------------------------------------
Casting Division                               1995 and 1998              Entiat, Washington and
                                                                          Tacoma, Washington
-----------------------------------------------------------------------------------------------------
Machining Division                             1994 and 1995              Wenatchee, Washington
-----------------------------------------------------------------------------------------------------
                                                                          Sedro-Woolley,
Engineering & Fabrication Division             1999 and 2000              Washington and
                                                                          Edmonds, Washington
-----------------------------------------------------------------------------------------------------

-----------------------------------------------------------------------------------------------------
EUROPEAN AEROSPACE GROUP
-----------------------------------------------------------------------------------------------------
Casting Division                               1998                       Sittingbourne, England
                                                                          Rochester, England and
                                                                          Worcester, England
-----------------------------------------------------------------------------------------------------
Forming Division                               1998                       Welwyn Garden City,
                                                                          England and
                                                                          Birmingham, England
-----------------------------------------------------------------------------------------------------
</TABLE>

*  We formed the Applied Technology Division through internal expansion in
   fiscal 2000.

Business Strengths

Significant Customer Base

We have a strong, diverse international customer base, which includes many of
the world's leading companies.  Our customers over the past year have included
companies such as: Advanced Bionics Corporation, Aeronautical Macchi
Manufacturing Corporation ("Aermacchi"), Agilent Technologies, Inc., BAE SYSTEMS
plc ("BAE Systems", the result of the merger during the year of two customers -
British Aerospace plc and Marconi Electronic Systems), BFGoodrich Company's
Aerostructures Group ("BFGoodrich"), The Boeing Company ("Boeing"), Deere &
Company, European Aeronautic Defence and Space Company N.V. ("EADS", formed upon
the merger of our customers Aerospatiale Matra S.A., Construccciones
Aeronauticas S.A., and DaimlerChrysler Aerospace AG), GKN Westland

                                       2
<PAGE>

Aerospace, Inc. ("GKN Westland"), Honeywell International Inc. ("Honeywell",
formed upon the merger during the year of our customers Honeywell Inc. and
AlliedSignal Inc.), Litton Marine Systems, Inc., Lockheed Martin Corporation,
Northern Telecom Ltd. ("Northern Telecom"), Northrop Grumman Corporation
("Northrop Grumman"), Paccar Inc. ("PACCAR"), Parker Hannifan Corporation,
Raytheon Company, Rolls-Royce plc ("Rolls-Royce"), Schlumberger Ltd., and TRW
Inc. (which acquired our customer Lucas Aerospace during the year).

Diversity of Product Offerings and Capabilities

We design and manufacture a broad range of precision cast, formed, machined,
finished, and fabricated metal products, as well as a broad range of specialized
electronics components and sub-assemblies.  We collaborate with many of our
customers to develop products that meet specific design or customization
requests. We believe that one of our key strengths is our ability to provide
total solutions to our customers.  We also believe that our experience and
capabilities in providing specialty processes and working with the changing
needs of our customers will be beneficial in allowing us to respond to changing
market trends in the industries that we already serve and responding to the
needs of customers in new markets.

Strong Position in Major Aerospace and Defense Programs

We supply components and parts to Boeing for each of Boeing's 737, 747, 757, 767
and 777 commercial aircraft construction programs and to members of the Airbus
consortium for Airbus' A300/310, A318-A321 and A330/340 commercial aircraft
construction programs. In addition, we participate in major defense and military
aircraft programs in the U.S. and Europe.

Strong Technology Position

We utilize specialized manufacturing techniques, advanced materials science,
integrated design, process engineering, and proprietary technologies or
processes in the design and manufacture of our products.  Our U.S. Electronics
Group alone owns 29 U.S. patents and uses a combination of patented technology,
trade secrets and other proprietary technology in the manufacture of state-of-
the-art electronic components and packages.  Our U.S. Aerospace Group has a
broad base of expertise in precision machining and the manufacture of cast
aluminum products using lost foam, sand and permanent mold casting technologies.
The group's Engineering & Fabrication Division employs a sophisticated group of
professional engineers, who specialize in turn-key design and build, machine
designs, engineering research and development, and total system engineering.
Our European Aerospace Group has specialized expertise in casting aluminum and
magnesium products using sand and investment casting techniques and its licensed
"Sophia Process" casting technology.  The group also has expertise in
superplastic forming of titanium sheet and stretch forming of aluminum sheet.
We are continually working to develop new proprietary technologies, and, in
addition to the numerous patents that we own or have pending, we maintain an
ongoing program of evaluating and protecting our proprietary rights and
processes.

Strategies

Our objective is to be a world class manufacturer that generates profitable
growth by integrating manufacturing processes, introducing new products, and
developing new customers in targeted markets.  We believe that pursuing the
following business strategies will enable us to increase market penetration,
create operating efficiencies, and enhance our competitive position.

                                       3
<PAGE>

Integrate and Consolidate Operations

During the 2000 fiscal year, we made substantial progress in integrating and
consolidating our operations.  By doing so, we plan to be able to reduce costs
and increase operating efficiencies, while providing more complete and faster
solutions to our customers.  In the past year, we completed the centralization
of our information technology infrastructure, adopted and installed new software
systems where appropriate, and made changes calculated to improve communications
and information flow within and between our operating groups.  We simplified our
organizational structure, established direct lines of accountability, and
enhanced and standardized our business processes.  We also standardized a number
of manufacturing processes, implemented cellular manufacturing processes and
lean manufacturing initiatives, and we are in the process of preparing for and
obtaining ISO 9001 or ISO 9002 certification for most of our operations.

Enhance Sales and Marketing Functions

During the 2000 fiscal year, we also solidified our sales force and expanded and
redirected our sales representative networks.  We have the opportunity to
leverage customer relationships to supply more complete systems by providing
products that combine the technologies and manufacturing abilities of our
different groups.  Consequently, we have focused on cross-selling efforts
between our operating groups.  We have also focused on improving our ability to
successfully manage joint sales efforts between our U.S.- and European-based
groups.

Offer Complete Solutions

We are vertically integrating our manufacturing processes, with the goal of
improving operating efficiencies and increasing profit margins. A key component
of this strategy is to use our expertise in advanced materials science and in
the manufacture and assembly of precision products to identify new products,
services, technologies and markets and to provide customers with total
solutions, from design to assembly.  Commercial aircraft manufacturers, defense
contractors, and leading manufacturers in other industries are continuing to
move toward purchasing from a smaller number of suppliers that can supply more
complete systems and pre-assembled parts.  We are positioning the Company to be
one of those suppliers.  By producing products that integrate our expertise in
casting, forming, machining and fabrication with our expertise in the
manufacture of higher-margin connectors, seals, capacitors, filters, and
electronic packages, we expect to improve profit margins and position the
Company to capture a larger share of our customers' total product requirements.

Diversify Customer Base

We believe that two keys to our long-term success will be diversification of our
customer base and expansion of our proprietary technologies into new markets.
We have always believed that our proprietary technologies give us advantages
that many of our competitors do not have.  Over the past year, we have become
even more engineering driven.  We do not just make parts based on a drawing - we
are able to provide design and modeling services to our customers, as well.  To
further these efforts, we formed our Applied Technology Division in fiscal 2000.
At the same time that our older divisions, such as the Machining Division, are
expanding outside their historical roles into new industries, the Applied
Technology Division is making opportunities to supply components to the fuel
cell, telecommunications, and advanced medical products industries.  As a result
of these efforts, we

                                       4
<PAGE>

plan not only to reduce our reliance on the cyclical aerospace industry, but
also to become an important part of emerging industries.

Internal Growth

We have grown historically primarily through acquisition.  We believe that there
are and will continue to be opportunities to grow and enhance profitability
through acquisition.  However, we currently plan to focus our growth efforts
internally through integration of manufacturing processes, development and
refinement of our proprietary technologies and new products, expansion of sales
penetration with existing customers, enhancement of engineering and value-added
processes, and development of new customers in targeted markets.

Industry Overview

Aerospace

Since 1998, previously favorable trends in the commercial aerospace industry
have been tempered by the Asian financial crisis, efforts by airlines and
airplane manufacturers to reduce costs, and other events, but industry analysts
and aircraft manufacturers still expect overall growth in air traffic patterns
and the demand for new aircraft.

Demand for aerospace components is closely related to delivery and use rates for
commercial aircraft. Delivery and use rates are in turn directly related to the
actual and projected volume of passenger and freight traffic, average aircraft
age, and global fleet size. According to the Boeing 1998 Current Market Outlook,
world air traffic grew 6% from 1996 to 1997, following a 7% increase in the
previous year.  However, the Boeing 1999 Current Market Outlook reported that
air travel in 1998 varied from the trend, particularly because of decreases in
Asian air traffic.  In 1999, Boeing revised its estimate for the growth rate of
world air travel over the next ten years to a rate of approximately 4.7% per
year.  In 2000, Boeing estimated growth rate of world air travel over the next
20 years will be approximately 4.8% per year.  Airbus forecasts a similar growth
rate, of 5% per year.  Boeing has also projected that the world jet fleet will
grow from an operating fleet of 12,600 commercial aircraft at the end of 1998 to
approximately 19,100 aircraft (net of retirements) at the end of 2008 and that
the total market potential for new commercial aircraft between 2000 and 2019 is
22,315 commercial aircraft, for a total world fleet in 2019 of 31,755 commercial
aircraft.

In 1999, Boeing delivered 620 new commercial aircraft, compared to 559 new
commercial aircraft in 1998 and 320 in 1997.  In 1999, Airbus delivered 294 new
commercial aircraft, compared to 229 in 1998 and 182 in 1997.  Boeing has
announced that it delivered 275 commercial aircraft through July 31, 2000, as
compared to 313 delivered in the first half of 1999.  As of July 31, 2000,
Boeing had received orders in 2000 for 342 commercial aircraft.  Total Boeing
orders in 1999 and 1998 were 389 and 648, respectively.  As of July 31, 2000,
Airbus had announced orders in 2000 for 465 commercial aircraft.  Total Airbus
orders in 1999 and 1998 were 476 and 556, respectively.

Consolidation of Supply Base

As in other transportation segments, aircraft manufacturers and defense
contractors have been aggressively searching for ways to improve the quality and
reduce the cost of their manufactured products. One major area of focus has been
the manner in which they work with their supply base. Similar to automotive
manufacturers, aircraft manufacturers and defense contractors have increasingly

                                       5
<PAGE>

become product designers and assemblers rather than vertically integrated
manufacturers. As a result, these manufacturers are outsourcing component
manufacturing to independent suppliers, seeking to benefit from an independent
supplier's lower cost structure and specialized manufacturing knowledge.
Suppliers that demonstrate an ability to effectively deliver a high quality
product on the required delivery schedule at a reasonable cost will benefit from
this shift. In addition, commercial aircraft manufacturers are tending, and
defense contractors are being strongly encouraged by the U.S. Department of
Defense, to purchase from suppliers that can supply more complete systems and
pre-assembled parts. These shifts are leading to a consolidation in the supply
base. Certain segments of the aerospace supply base are already consolidated,
such as engines, avionics and landing gears. Other segments, however, including
structural components and electronics, remain fragmented. The Company believes
that this trend toward consolidation presents an opportunity for suppliers with
the financial and management resources to complete acquisitions and expand their
operations.

Electronics

The electronics industry is enjoying growth in the Company's specific sectors,
and researchers expect that growth to continue through at least 2004.  According
to Fleck Research, a division of Global Connector Research Group, Inc., the top
ten manufacturers of connectors, cable assemblies, backplane and interconnect
devices combined produced over $11 billion worth of product in 1997, and growth
is forecasted at a rate of 4.3% through year 2002.  Fleck Research has
forecasted that worldwide shipments of those products will grow by 7.1% in 2000.
The Company believes that the type of products it sells constitutes a very small
portion of this market.

Growth in the high reliability electronics industry has been fueled by several
factors, including the rapid pace of technological advancement and development
of new satellite and telecommunications products.  The growth in demand by these
sophisticated customers has induced manufacturers to create more complex designs
of lighter, more efficient configurations and higher levels of performance.
Additionally, international demand for advanced electronics components is
growing rapidly as these new developments enter the arena of available
solutions.

                                       6
<PAGE>

Products, Processes and Markets

Our products, manufacturing processes and markets in fiscal 2000, and the
industry segments in which we operate, are summarized below.  For financial
information about operational segments and geographic areas, see "Notes to
Consolidated Financial Statements - Note 5" in the Company's financial
statements for May 31, 2000.


<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------
Segment        Group          Division          Manufacturing               Sample Products
                                                  Processes
------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------
<S>        <C>             <C>             <C>                       <C>
           U.S.            Interconnect    Design and manufacture    Electronic connectors,
           Electronics                                               packages and assemblies with
                                                                     ceramic and glass hermetic
                                                                     seals
E                          ---------------------------------------------------------------------------
L                          Filter          Design and manufacture    Ceramic discoidal
E                                                                    electromagnetic filters and
C                                                                    capacitors
T                          ---------------------------------------------------------------------------
R                          Bonded Metals   Explosive bonding and     Metallurgically welded metals
O                                          forming of dissimilar     for use in electronic
N                                          metals                    connectors and assemblies
I                          ---------------------------------------------------------------------------
C                          Display         Design and manufacture    Relays and solenoids;
S                                                                    ruggedized flat panel displays
                           ---------------------------------------------------------------------------
                           Applied         Design and manufacture    Medical product components;
                           Technology                                fuel cell components
------------------------------------------------------------------------------------------------------
           U.S.            Casting         Sand; lost foam; and      Aircraft and truck parts
           Aerospace                       permanent mold casting
                           ---------------------------------------------------------------------------
                           Machining       Precision machining of    Aircraft parts
                                           bonded and cast metals
A                          ---------------------------------------------------------------------------
E                          Engineering     Metal fabrication;        Tooling and structures for
R                          & Fabrication   design                    aircraft manufacture;
O                                                                    aviation tool design; factory
S                                                                    integration
P          -------------------------------------------------------------------------------------------
A          European        Forming         Hot and superplastic      Jet engine bulkhead
C          Aerospace                       titanium forming; cold    components; airframe and
E                                          stretch aluminum forming  engine details; aircraft skin
                                                                     panels; leading edges
                           ---------------------------------------------------------------------------
                           Casting         Sand casting;             Aircraft parts; aircraft
                                           investment casting;       engine parts; high
                                           Sophia casting;           performance motorsport engine
                                           machining                 and gearbox parts
------------------------------------------------------------------------------------------------------
</TABLE>



                                       7
<PAGE>

The following chart shows the percentage of total revenue from each division for
the past three fiscal years.  The percentages for fiscal years after fiscal 1998
reflect the acquisition of Aeromet in July, 1998.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
Segment          Group          Division                      Years Ended May 31,
-----------------------------------------------------------------------------------------------------
                                                         1998              1999              2000
                                                        -----             -----             -----
-----------------------------------------------------------------------------------------------------
<S>         <C>              <C>                       <C>               <C>                <C>

E                            Interconnect               21.20%            13.30%            12.80%
L                            ------------------------------------------------------------------------
E
C           U.S.             Filter                     *                 *                 *
T           Electronics      ------------------------------------------------------------------------

R                            Bonded Metals              *                 *                 *
O                            ------------------------------------------------------------------------
N
I                            Display                    *                 *                 *
C                            ------------------------------------------------------------------------
S                            Applied
                             Technology                 N/A               N/A               *
-----------------------------------------------------------------------------------------------------
A
E                            Casting                    26.50%            12.60%            12.80%
R                            ------------------------------------------------------------------------
O           U.S.
S           Aerospace        Machining                  37.50%            16.30%            *
P                            ------------------------------------------------------------------------

A                            Engineering &              N/A               N/A               *
C                            Fabrication
E          ------------------------------------------------------------------------------------------

            European         Forming                    N/A               25.10%            24.90%
            Aerospace        ------------------------------------------------------------------------

                             Casting                    N/A               24.10%            25.60%
-----------------------------------------------------------------------------------------------------
</TABLE>

     *  Less than 10%

U.S. Electronics Group

Our U.S. Electronics Group develops, manufactures and markets a wide array of
complex hermetically-sealed electronic connectors and assemblies, ceramic
capacitors and filters, relays and solenoids, and flat panel display units.
These products are used for specialized applications in the aerospace, defense,
telecommunications, energy, medical, and electronics industries.  Many of these
products involve sealing and encapsulation of electronic components and are
specifically engineered on a customized basis to withstand degradation or
destruction in harsh environments, such as the ocean, space and the human body.
These environments experience extremes in temperature, pressure, corrosiveness
and impact that can make product repair or replacement difficult or impossible.
To meet the demands of these challenging applications, we have developed or
acquired numerous patents and many proprietary processes.

                                       8
<PAGE>

     Interconnect Division

In Wenatchee, Washington, our U.S. Electronics Group's Interconnect Division
designs and manufactures hermetically sealed electronic connectors,
feedthroughs, assemblies and instrument packages.  Electronics must be
hermetically sealed when used in locations where the external environment can
penetrate the unit.  One of the division's product lines uses a cost-effective,
traditional glass-to-metal seal, which provides an effective seal in less
demanding environments.   This technology is used for products such as waveguide
windows and certain types of electronic feedthroughs.  The division's second
line of hermetically sealed products uses a more expensive, proprietary ceramic
sealant, called Kryoflex(R).  The Kryoflex sealant is used in products that must
withstand extremely invasive environments, such as satellite and weapons
systems, implantable medical devices, down-hole oil drilling tools, and the
fiber optic connectors used on the International Space Station.  Kryoflex has
several formula variations, which make it compatible with many different metal
alloys.  We manufacture both the glass seal and the ceramic seal products to
customer specifications using the division's engineering and design expertise,
metallurgical and ceramic analysis capabilities, ceramics formulation, laser
welding, and production processes.  We form the connectors' packages and
assemblies on the division's machining centers, CNC lathes, Swiss screw
machines, vacuum brazing furnaces, and CNC-controlled laser welding machines.
The division also has the capacity to electroplate and chemically film its
products.  The division also manufactures hermetically bonded products using our
proprietary ceramic adhesive.  This ceramic adhesive bonds metals that will not
normally bond, such as copper and stainless steel.  When combined with our
explosive bonding technology, the resulting component is nearly as light as
aluminum, making it the preferred product where weight minimization is
important, such as in space applications.  We also hold patents in metal matrix
composite technology and other advanced technologies.

The Interconnect Division has been audited and has received its certificate of
registration to the ISO 9001 standard.  The division has also received a
compliance certificate to the AS 9000 standard.  The ISO 9001 and the AS 9000
standards are internationally recognized certifications of quality.  AS 9000 is
the more demanding aerospace quality management system standard.  The
registration process requires a company to:  1) document and implement a quality
management system that meets or exceeds all of the requirements of the
standards, 2) choose an accredited registrar (in our case, TUV Essen), 3) have a
full quality management system audit conducted by an accredited registrar, and
4) identify and correct any issues that arise during the audit.  Once the
company has corrected any deficiency, the accredited registrar forwards the
audit package to the Registrar Accreditation Board with a recommendation for
registration.

     Filter Division

Our U.S. Electronics Group's Filter Division designs and manufactures very
small, specialized multilayer discoidal (round) ceramic capacitors and filters.
These products are advanced electronic circuit filtering devices designed to
filter out electromagnetic interference ("EMI") and other undesirable electrical
signals that pose significant problems for the manufacturers and users of high-
performance, high-reliability electronic systems operating in harsh
environments.  The division's products include mini screw-in filters for
telecommunications, aerospace and defense applications, ring laser gyros,
commercial eyelets for IFF (identification friend or foe) systems and satellite
amplifiers, high reliability bolt configurations for the space shuttle's main
engine controllers, filter pins, custom filter assemblies, and broad band
filters for military display systems.  The division produces the smallest
available multi-layered discoidal capacitor in the industry.  The division is an
approved supplier of EMI devices to most aerospace and defense contractors, and
our U.S. Electronics Group

                                       9
<PAGE>

uses these filters in its own hermetically sealed electronic products. The
division has a self-contained facility in Wenatchee, Washington with assembly
and product testing capabilities. The division has received a number of military
and industry qualification ratings. The Filter Division has been audited and has
received its certificate of registration to the ISO 9001 standard and its
compliance certificate to the AS 9000 standard.

     Bonded Metals Division

In Sequim, Washington, our U.S. Electronics Group's Bonded Metals Division bonds
similar and dissimilar metals, using an explosive metallurgical welding
technology.  Using this technology, an explosive charge permanently fuses metals
on the molecular level.  Many of these metals would otherwise be incompatible,
such as aluminum and stainless steel.  The result is a strong but lightweight
metal that can be machined and welded into complex assemblies.  The division
finishes the metals to the customer's specifications using milling, welding,
lathe and rolling techniques, and tests the finished products in its
metallurgical lab using non-destructive testing such as dye penetration and
ultrasonic scanning.  The division also uses its explosive technology to shock-
harden metals for use in applications where extremely high tensile strength is
required, such as rail track intersections and switch components, and to
pressure form complex metal parts.  The division's explosively bonded metals are
used by our U.S. Electronics Group and other customers in the aerospace,
defense, energy, medical, and marine industries.  Explosively bonded metals are
used to fabricate products for highly specialized applications such as
satellites, aircraft and missiles, where weight minimization is a critical
factor.  The metals are also used for products such as oil drill heads, aircraft
engine heat exchange tubes, flanges, and feedthroughs for nuclear particle
accelerators, where strength at high temperature and heat dissipation are
critical, and for products such as naval interfaces and structures, where
galvanic corrosion resistance is a requirement.

     Display Division

Relays and Solenoids.  In Vancouver, Washington, our U.S. Electronics Group's
Display Division designs, manufactures and markets electromechanical devices,
such as relays, solenoids, sensors, electronic assemblies, actuators, and time
delays used in a wide variety of satellite, aircraft and military hardware
applications.  These high reliability but low power switches use only one to ten
amperes, making them suitable for applications such as satellite power bus
controllers and aircraft fuel control valves.  They have also been used in many
space vehicles launched by the United States and European countries.  The
division has specialized equipment for CNC milling, turning and welding that is
used for producing these products.

Flat Panel Displays.  The Display Division's primary focus is the design and
manufacture of ruggedized, optically enhanced liquid crystal displays and
optical filters, which allow users to view images at a much higher resolution
than standard commercial units.  The division's flat panel display product is an
extended temperature commercial liquid crystal display sandwiched between
specialized layers of glass and optical filters in the front, heating and
cooling units, and a computerized optical enhancer, in the back.  The entire
unit is mounted in a heavy-duty housing.  Our flat panel displays are used for
high ambient light commercial applications that range from GPS displays and
light control filters on private and commercial aircraft to ground vehicle
displays and automatic teller machine displays.  During fiscal 2000, the
division entered into a strategic partnership with NEC Electronics, Inc., a
world leader in display technology.  The Display Division is ISO 9001 compliant.

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     Applied Technology Division

We formed the Applied Technology Division of our U.S. Electronics Group toward
the end of fiscal 2000.  The purpose of the division is to apply our proprietary
and patented technologies to provide technical solutions to difficulties faced
by high-tech manufacturers that are challenged by extreme environmental
conditions, primarily in the fuel cell, telecommunications, and implantable
medical products industries.  The division is focusing on providing solutions in
the areas of ceramic diffusion bonding, exotic metals composites, interconnect
stability, and thermal stress distribution with biocompatible materials.  In the
fuel cell area, the division develops and manufactures processes in the assembly
of fuel cells stacks, heat exchangers and fuel process reformers for pem and
solid-oxide fuel cells.  The division also has applied our zirconium-metal
fusion technology to the manufacture of a fuel cell generator solid-oxide fuel
cell for use in space exploration.  Additional research is being performed on
planar fuel cell stacks.  The division has also used the zirconium-metal fusion
technology to assist a manufacturer of neurostimulator devices in overcoming
technological barriers.  During the year, we also produced a titanium-copper-
molybdenum composite electronic enclosure and applied for a patent on this
technology, which we believe will allow us to produce even lighter, more durable
electronics packages with improved thermal conductivity.  The Applied Technology
Division is in its infancy, but our goal is to expand this division by
leveraging and finding new applications for our existing and new materials
science technologies.

U.S. Aerospace Group

     Casting Division

At our facility in Entiat, Washington, our U.S. Aerospace Group's Casting
Division designs and manufactures precision cast aluminum parts using permanent
mold, sand, and lost foam casting technologies. At our facility in Tacoma,
Washington, until November 30, 2000, the division designed and manufactured
aluminum, bronze, iron, and steel parts using sand casting technology.  We sell
the division's cast parts principally to the transportation and aerospace
industries.  During fiscal 2000, the division began to assist customers in
converting components that have traditionally been machined and assembled into
lighter weight cast components.  The Casting Division has been audited and has
received its certificate of registration to the ISO 9002 standard and has
received its compliance certificate to the AS 9000 standard.  As of November 30,
2000, we closed our Tacoma facility.  We are currently evaluating our options
with respect to the U.S. Aerospace Group's Casting Division.

Permanent Mold Casting.   The permanent mold process is well-suited for high
strength, long production life parts that do not require frequent changes in
design and can be made in high volume. The division uses this process primarily
to produce components used in diesel engines and other structural parts for the
transportation industry. The permanent mold process uses a cast iron mold to
shape the part to be cast. Molten aluminum is ladled into the heated mold and,
once cooled, the casting is removed from the mold. As the mold is not destroyed
in the production process, it can be reused.

Sand Casting.   The sand casting process is more appropriate for lower volume
parts.  It is also appropriate for parts produced in iron and steel, which have
high melting temperatures, prohibiting the use of many other casting processes.
The division uses this process to produce parts for the aerospace industry, such
as housings.  This process uses a wood, plastic, or aluminum pattern of the part
to be cast.  An automatic molding machine hydraulically squeezes molding sand to
accurately reproduce the pattern. After the molten aluminum is poured into the
mold, the sand is removed, leaving the casting. The sand mold is destroyed in
the process, but the sand may be recycled for future moldings. The

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<PAGE>

division also employs an SO\\2\\ core making process, which produces sand cores
and molds without the use of heat, providing for more dimensional accuracy and
increased productivity.

Lost Foam Casting.   The lost foam process is well-suited for producing parts
with complex patterns, because it reduces the amount of machining that would be
required if the parts had been made with sand or permanent mold castings.  We
use this process to produce support brackets and housings primarily for the
transportation industry.  In the lost foam process, the pattern is created from
expanded polystyrene beads. The foam pattern is then suspended in a large metal
flask and surrounded with dry sand. Molten aluminum is poured directly on the
pattern, which vaporizes as the aluminum replaces every detail of the pattern.
The lost foam process allows for complex details of a part to be cast with
little or no touch-up, and the tooling used to create the polystyrene patterns
has an unlimited life because the tooling only comes in contact with the
polystyrene beads.

     Machining Division

Our U.S. Aerospace Group's Machining Division operates a precision machine shop
in Wenatchee, Washington that produces precision machined components, structural
parts and assemblies principally from aluminum, titanium, stainless steel and
explosively bonded metals. The Machining Division manufactures machined and
sheet metal parts and assemblies that are used for primary and secondary flight
components within aircraft.  The division uses computerized numerical control
("CNC") machining cells to manufacture particularly complex components and
assembly housings and also provides value-added services, such as painting and
electroplating.  The division builds its machined products either to customer
specifications or according to an engineering and tooling design developed by
the division to suit a customer's particular need. The division is directly
linked by computer to Boeing to allow immediate access to the drawings for
Boeing parts. The division inspects and tests its machined products at various
stages of production using non-destructive methods such as X-ray, ultra-sound,
manual and computerized measuring instruments, eddy current, and dyes before the
products are passed for shipment to the customer.  During fiscal 2000, we also
added equipment and personnel to this division to give it the capacity to
provide sheet metal products.  In response to changes in its customers'
manufacturing processes, the division often supplies its precision machined
parts on a "just in time to point of use" basis.

The Machining Division has historically supplied nearly all of its products to
the commercial aerospace and defense industries.  However, the division's sales
and profitability have been affected by slowdowns at Boeing since approximately
fall 1998.  As a result, we increased our efforts to reduce the division's
dependence on aerospace work.  During fiscal 2000, we received significant
orders from companies such as Northern Telecom (telecommunications) and Applied
Materials, Inc. (semiconductors), for components intended for high-tech, non-
aerospace uses that require the precise work of our Machining Division.  These
orders total approximately $2.5 million, a substantial portion of which will be
shipped in fiscal 2001.  We are continuing to look for ways to offer our
capabilities to leaders in these new markets.

The division's operations are DI-9000A Boeing approved.  The division has also
been audited and has received its certificate of registration to the ISO 9002
standard and has received its compliance certificate to the AS 9000 standard.
The division has won numerous quality and service awards from customers.

Our U.S. Aerospace Group also has machining capabilities at its Entiat and
Tacoma, Washington facilities to support its Casting Division.

                                       12
<PAGE>

     Engineering & Fabrication Division

Our U.S. Aerospace Group's Engineering & Fabrication Division resulted from the
combination of two companies that we acquired in fiscal 2000.  In the beginning
of the fiscal year, we acquired Skagit Engineering & Manufacturing, Inc., in
Sedro-Woolley, Washington.  This segment of the business fabricates component
parts, completed assemblies and tooling, and fully manufactured industrial
products, such as heavy duty mobile transporters for use by aircraft
manufacturers in moving large sections during the manufacturing process and
complete aircraft automated control assembly line tools.  Later in the fiscal
year, we acquired NOVA-TECH Engineering, Inc., in Edmonds, Washington.   This
segment of the business provides comprehensive aerospace design and related
engineering services, primarily for the commercial and defense aerospace
industries.  Our engineering services include aircraft tool design,
manufacturing systems, machine design, stress analysis engineering, systems
engineering, and technical supervision. This division has 20 CATIA seats,
linking it to Boeing's computer system, for access to and delivery of design
work.  These computer aided design seats are used by some of our customers,
including Boeing, and allow us to transfer designs and work closely with our
customers in the design of aircraft parts.  The division recently acquired
licenses to the Delmia/Deneb digital manufacturing software platform to assist
with design, simulation, control and monitoring of production manufacturing
systems.  The division also provides tools and machines for non-aerospace
industries.

European Aerospace Group

     Forming Division

At our Welwyn Garden City and Birmingham facilities in England, our European
Aerospace Group's Forming Division uses hot and cold metal forming technologies
to manufacture titanium and aluminum assemblies and details for the commercial
aerospace and defense industries.  The division also performs finishing,
welding, brazing and riveting processes on these parts.  Testing of products is
done using non-destructive techniques and in-house X-ray facilities. Interactive
discussions with customers enable the division to closely match component design
to the most suitable forming process.  The division is approved to the ISO 9002
standard.

Hot and Superplastic Forming of Titanium.   Our Welwyn Garden City facility
specializes in hot and superplastic forming of titanium, and we believe it has
the largest independent capability in the European Union for that process.
Unlike most sheet metal materials, titanium and its alloys are extremely
difficult to form in a cold condition. To overcome this, we have developed a
variety of hot forming processes, including hot die forming, hot brake press
forming, superplastic forming, gas blow forming, and hot circular stretch-
forming.  These processes maximize weight savings, maintain structural
integrity, minimize cost, and enable the designer to manipulate the developing
alloys into complex shapes.  The forming equipment consists of a range of 16 hot
forming and superplastic forming presses with tonnage from 150 to 1500 tons.
Most forming tools are machined from oxidation resistant nickel chrome steel
castings weighing up to four tons.  The division designs the necessary tooling
using its in-house pattern facility.  The division also has the capability to
chemically mill three-dimensional components in titanium. We market the
division's hot-formed titanium products primarily to the commercial aircraft,
helicopter and military aircraft markets. The division's titanium products
include jet engine Nacelle bulkhead components, airframe and engine details, and
erosion shields for helicopters. The division's titanium products are included
on the Airbus model A318-321 and A330/340

                                       13
<PAGE>

aircraft, the Boeing model 737 aircraft, the Dash 8-400 aircraft, the Embraer
135 and 145 aircraft, and the Dornier 728 aircraft.

Cold Forming of Aluminum Alloys.   At our Birmingham facility, our European
Aerospace Group's Forming Division specializes in the stretch and cold forming
of aluminum alloys used for aircraft skin panels, leading edges and acoustic
panel liners. Stretch forming is a process well suited to producing aircraft
skin panels and leading edges. Specialized equipment in the Birmingham facility
has the capability to form sheets up to 8 feet wide and up to 13 feet long, with
stretching loads of up to 700 tons being applied. Most tools are machined from
oxidation-resistant stainless steel castings, and forming dies up to four tons
can be handled. Together with specialist gripper jaws and rotational platen,
this enables the division to stretch-form aluminum alloys into a wide variety of
shapes and sizes.  The division's capabilities extend from design to completion,
including tooling design and manufacture, forming, chemical milling, trimming,
assembly, and quality control.  We market the division's formed aluminum alloy
products primarily to the aerospace market.

     Casting Division

In Rochester, Worcester and Sittingbourne, England, our European Aerospace
Group's Casting Division manufactures aluminum investment castings and aluminum
and magnesium precision sand castings.  The division is approved to the ISO 9002
standard.

Precision Investment Casting.   At our Worcester, England facility, our European
Aerospace Group's Casting Division manufactures aluminum investment casting
products, including aircraft and defense system components such as electronic
enclosures, aircraft engine outer guide vanes, navigation lights, wing tip
fences, winglet components, duct stators, and heads up display units. At our
Rochester, England facility, the division manufactures aircraft components such
as pressure tight fuel connectors. The versatility, accuracy and replicability
of the investment casting process provides many advantages over more traditional
methods of machining and fabricating metal products from solid components. The
investment casting process uses a metal die manufactured to required
specifications. The division's precision tooling capabilities permit production
of metal dies that incorporate a variety of details and features. A die can be
reused to produce the required number of parts without degradation to the
original die. The division's production of the die gives the customer an
incentive to order additional units of the part from the Company.

Sophia Process Investment Casting.   The continual pursuit of product
improvement and cost reduction campaigns has led to the installation and
efficient utilization of the licensed Sophia casting process at our Worcester
facility.  Our European Aerospace Group's Casting Division is one of only four
licensees of the computerized "Sophia Process," which the division uses to
manufacture significantly larger, more complex castings than can be made as a
single part using more traditional investment casting processes.   Using this
technology, the division can produce components up to 1.3 cubic meters in one
piece.  This process capability, coupled with the development of new and
patented alloys, creates a significant opportunity to provide customers with an
additional and economic choice when selecting between a machined, fabricated,
composite, or cast structure.  Parts made with the Sophia Process have
relatively thin wall thickness but have strength and ductility values comparable
to fabricated, forged and machined solid components.  The Sophia Process
stringently controls the heat level and process parameters to make lighter but
stronger components that resist fracture and fatigue.  The process reduces
machining, fabrication and assembly costs by eliminating both doublers at
material interfaces and the weakness and stress associated with riveted
assemblies.  The division uses high strength alloys with good castability to
ensure that the integrity and enhanced properties from one casting are identical

                                       14
<PAGE>

to the next, and to achieve the desired combination of tensile strength,
ductility and elongation. Parts made with the Sophia Process are used for the
commercial aerospace, defense and transportation industries. Such applications
include civil aircraft, military aircraft, missiles and underwater weapons
applications and applications for the motorsport industry. Our European
Aerospace Group uses the Sophia Process to produce components for the Airbus
A320, A330 and A340 aircraft, such as navigation light housings and wing tip
fences, as a single part, and to produce slat can wing components for Boeing's
737 aircraft.

Sand Casting.   At our Sittingbourne, England facility, our European Aerospace
Group's Casting Division manufactures aluminum and magnesium alloy precision
sand castings, including machined and finished parts for the commercial
aerospace, defense and motorsport industries. Sand casting is suitable for
products that are larger than typical investment casting parts.  It is also
suitable for products that require heavy wall sections. These products include
aircraft engine heat exchangers and air intakes, aircraft engine fuel pump
housings, aircraft windscreen canopies, and high performance motorsport engine
components and gearboxes.  For such customer requirements, sand casting provides
an effective method of producing components with strength and uniformity. The
division has made significant advances in both the process and materials
technology for magnesium and aluminum sand castings. The division engineers
patterns utilizing computer assisted design technologies to achieve repeatable
high casting integrity and enhanced mechanical properties. The division has
complete non-destructive testing and inspection facilities, such as dye
penetrant flaw detection and X-ray testing of components, as required by the
rigorous standards of the aerospace industry.

Machining.   Our European Aerospace Group also has a sophisticated machining
center that supports the group's casting and forming operations. The group's
machining facility has the technical capabilities to provide a full range of
machining services for complete production and finishing of components,
including design, pattern production, casting and final machining of a
component.  The machining facility also performs specialized machining of small
detail components in steel and titanium.

For our fiscal year ended May 31, 2000, we had net sales of approximately $113
million, with the European Aerospace Group contributing approximately $57
million in net sales.  On October 31, 2000, we announced our intention to sell
our European Aerospace Group in order to reduce our outstanding 11 1/4% senior
subordinated notes.  As of May 31, 2000, we had approximately $64 million in
principal amount of 11 1/4% senior subordinated notes outstanding.  Because we
have just begun the process of seeking buyers for our European Aerospace Group,
we do not know whether we will be successful in selling that group and, if
successful, we do not know the amount of net proceeds that would be available to
reduce our 11 1/4% senior subordinated notes.  If, at such time as we have
committed to a formal plan of disposition of the European Aerospace Group, any
impairment of the assets of that group can be reasonably determined, we will
record any such impairment loss in our consolidated financial statements.
Although we cannot currently reasonably determine the extent of any such
impairment loss, it could be substantial.

Sales and Marketing; Distribution

We market our products using a combination of direct sales and outside sales
representatives.  In addition, we maintain internal customer service staff and
engineering capabilities to provide technical support to customers.  In the 2000
fiscal year, we have consolidated our marketing efforts within our operating
groups and expanded both our direct sales forces and our sales representative
networks.  In some cases, we have changed sales representatives in order to take
advantage of synergies and conduct sales efforts more efficiently.  For example,
we have recently retained one sales representative

                                       15
<PAGE>

organization to represent both our European Aerospace Group and our U.S.
Aerospace Group with Boeing. Our U.S. Electronics Group markets its products in
the United States, Europe and Asia through a network of manufacturer
representatives and resellers, generally established on a geographic basis. Our
U.S. Aerospace Group uses both an inside sales force and sales representatives
focused on particular regions or customers. This group's marketing efforts have
previously focused on the Western United States. Over the past year,
particularly with the addition of the Engineering & Fabrication Division and the
implementation of a program to coordinate U.S. and European efforts, the group
has expanded its marketing efforts beyond its traditional markets, into other
regions of the United States and internationally. Our European Aerospace Group
utilizes its own employee sales force for sales of its products to customers in
the United Kingdom. This internal sales force is organized into two groups, one
group responsible for sales of precision castings and one group responsible for
metal formed products. The European Aerospace Group also uses independent agents
to market its products to customers in countries other than the United Kingdom,
including the United States. We believe that we have the opportunity to leverage
customer relationships to supply more complete systems by providing products
that combine the technologies and manufacturing abilities of our different
groups. Consequently, we are emphasizing cross-selling efforts between our
operating groups.

Customers

Our top ten customers in terms of revenues during fiscal 2000 were Boeing,
Rolls-Royce, PACCAR, Aermacchi, BAE Systems, GKN Westland, Northrop Grumman,
Northern Telecom, Honeywell, and BFGoodrich.  Only the top 4 customers
individually accounted for 5% or more of our revenues, with Boeing at
approximately 10%, Rolls-Royce at approximately 7%, PACCAR at approximately 6%,
and Aermacchi at approximately 5%.  Together, our top ten customers accounted
for approximately 46% of our sales during fiscal 2000.  We produce machined and
cast metal aircraft components for Boeing, Rolls-Royce and Aermacchi, and cast
metal heavy trucking components for PACCAR.  We do not have long-term contracts
with most of our major customers, and our long-term contracts generally permit
the customer to cancel their orders.  We depend on our customers continuing to
place orders for our products.  Because of the relatively small number of
customers for most of our products, our largest customers can influence product
pricing and other terms of trade.  If we were to lose any of our largest
customers, or if they reduced or canceled orders, our business and financial
performance could be harmed.

Our U.S. Aerospace and European Aerospace Groups currently serve substantially
different customer bases in similar markets.  For example, the U.S. Aerospace
Group supplies components and parts to Boeing for each of Boeing's 737, 747,
757, 767 and 777 commercial aircraft construction programs.  The European
Aerospace Group supplies components and parts for each of Airbus' A300/310, A320
family, and A330/340 commercial aircraft construction programs.  The Company's
sales are currently divided approximately equally between the United States and
Europe.  One of our goals is to take advantage of our position in both the
United States and European markets to provide access for our U.S. groups to
customers in Europe, and access for our European group to customers in the U.S.
Consequently, we are emphasizing cross-marketing efforts between our European
and U.S. groups.  One of the outcomes of these efforts has been the success of
our European Aerospace Group in obtaining new work in the U.K. from Boeing.

Backlog

We sell the majority of our products through individual purchase orders.  Many
of our customers would have the right to terminate orders by paying the cost of
work in process plus a related profit factor.

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Historically, we have not experienced a large number of significant order
cancellations. However, from time to time, customers cancel orders as a result
of a program being cancelled or for other reasons. As of May 31, 2000, we had
purchase orders and contractual arrangements evidencing anticipated future
deliveries, which we treat as backlog, through fiscal year 2002 of approximately
$80 million. We expect to deliver approximately $70 million of this backlog in
fiscal year 2001. As of May 31, 1999, we had backlog through fiscal year 2001 of
approximately $100 million. We may not be able to complete all of that backlog
and book it as net sales, if we experience cancellations of pending contracts or
terminations or reductions of contracts in progress.

Competition

We have substantial competition in many of the markets that we serve.  In the
electronics markets, our competitors include Amphenol Corporation, Hermetic Seal
Corporation, AVX Corporation, Spectrum Control, Inc., and Electronics Design and
Communications Instruments.  In the hot forming market, our primary competitors
include Die Barnes Group Inc. and the Carsons division of GKN Westland (North
America), the second of which we understand will be closing.  In the cold
forming market, we compete with companies such as AHF and Pendle.  In the U.S.
sand casting market, we compete with a number of West Coast and Midwest
foundries, including ConMetco in Oregon and North Carolina, Production Pattern
in California, Progress Foundry in Minnesota, and Wellman Dynamics in Iowa.  We
also compete with off-shore foundries, which tend to have lower costs.  Our
competitors in the European sand casting market include SFU, Stones, Haleys,
Hitchcock, and Teledyne.  In the investment casting market, our competitors
include the Cercast Group, Tital and Tritech.  In the precision machining
market, we compete with a number of regional machine shops.  Many of these
competitors have greater financial resources, broader experience, better name
recognition and more substantial marketing operations than we have, and they
represent substantial long-term competition for us.

Our competitors can make components and products similar to those we make using
a number of different manufacturing processes.  We believe that our
manufacturing processes, proprietary technologies and experience provide
significant advantages to our customers.  These advantages include high quality,
more complete solutions, competitive prices, and physical properties that meet
stringent demands.  However, competitors can use alternative forms of
manufacturing to produce many of the components and products that we make.
These competing products could be of the same or better quality and price as
those we produce.  We expect our competitors to continue making new
developments, and they could develop products that customers view as more
effective or more economical than our products.  In addition, our competitors
may introduce automation processes and robotics systems that could lower their
costs of production substantially.  If we are not able to compete successfully
against current and future competitors, and respond appropriately to changes in
industry standards, our business could be seriously harmed.

Raw Materials

Our European Aerospace Group obtains approximately 70% of its titanium from one
supplier and is subject to a lead time of approximately 65 weeks in ordering and
obtaining titanium.  While the European Aerospace Group generally has managed
the ordering process to obtain titanium when needed, a labor strike at the
supplier negatively affected the group's ability to obtain timely deliveries of
titanium during fiscal 1999 and into the 2000 fiscal year.  Although the
shortage of titanium did not have a material adverse effect on our European
Aerospace Group's business or on our overall financial condition, we lost some
business due to customers' dual sourcing contracts, and some customer orders

                                       17
<PAGE>

that were expected to be delivered in fiscal 1999 were delayed into fiscal 2000
and 2001. The effect of the strike emphasizes the fact that a failure to obtain
titanium or other raw materials when we need them, or significant cost increases
imposed by suppliers of raw materials such as titanium or aluminum, could damage
our business and financial performance. We generally have readily available
sources of all raw materials and supplies we need to manufacture our products
and, where possible, we maintain alternate sources of supply. However, we do not
have fixed price contracts or arrangements for all of the raw materials and
other supplies we purchase. We have experienced in the past shortages of, or
price increases for, raw materials and supplies, and shortages or price
increases may occur again in the future. Future shortages or price fluctuations
could have a material adverse effect on our ability to manufacture and sell our
products in a timely and cost-effective manner.

Proprietary Rights

Significant aspects of our business depend on proprietary processes, know-how
and other technology that are not subject to patent protection. We rely on a
combination of trade secret, copyright and trademark laws, confidentiality
procedures, and other intellectual property protection to protect our
proprietary technology. However, our competitors may still develop or utilize
technology that is the same as or similar to our proprietary technology.

We have 29 U.S. patents, 7 U.S. patent applications pending (including 3 allowed
applications), 1 PCT International patent applications pending, 7 patent
applications pending in non-U.S. jurisdictions, and 1 European patent
enforceable in the U.K. We can provide no assurance that any of the patent
applications will result in issued patents, that existing patents or any future
patents will give us any competitive advantages for our products or technology,
or that, if challenged, these patents will be held valid and enforceable. Most
of our issued patents expire at various times over the next 15 years, with 13
patents expiring over the next four years. These 13 patents, as well as six
other patents that recently expired, relate to products manufactured by our U.S.
Electronics Group and constituted approximately 0.9% of our consolidated revenue
in fiscal 2000. Although we believe that the manufacturing processes of much of
our patented technology are sufficiently complex that competing products made
with the same technology are unlikely, our competitors may be able to design
competing products using the same or similar technology after these patents have
expired.

Despite the precautions we have taken, unauthorized parties may attempt to copy
aspects of our products or obtain and use information that we regard as
proprietary. Existing intellectual property laws give only limited protection
with respect to such actions, and policing violations of these laws is
difficult. The laws of other countries in which our products are or may be
distributed do not protect products and intellectual property rights to the same
extent as do the laws of the United States. We could be required to enter into
costly litigation to enforce our intellectual property rights or to defend
infringement claims by others. Infringement claims could require us to license
the intellectual property rights of third parties, but licenses may not be
available on reasonable terms, or at all.

Environmental Matters

Our facilities are subject to regulations concerning solid waste disposal,
hazardous materials generation, storage, use and disposal, air emissions, waste
water discharge, employee health and other environmental matters. A number of
the metals, chemicals and other materials used in and resulting from our
manufacturing processes are classified as hazardous substances and hazardous
wastes. If we do not meet permitting and other requirements of applicable
environmental laws, we could be liable for damages and for the costs of remedial
actions. We could also be subject to fines or other penalties,

                                       18
<PAGE>

including revocation of permits needed to conduct our business. Any permit
revocation could require us to cease or limit production at one or more of our
facilities, which could damage our business and financial performance. We have
an ongoing program of monitoring and addressing environmental matters, and from
time to time in the ordinary course of business we are required to address minor
issues of noncompliance at our operating sites. From time to time, we identify
operations or processes that lack required permits or otherwise are not in full
compliance with applicable environmental laws. Although we believe these items
have not been material to date, we maintain an environmental compliance team,
and our policy is to take steps promptly to remedy any noncompliance.

We have a policy of obtaining environmental assessment reports in connection
with the acquisition of properties at which we believe historical operations
could have caused adverse environmental conditions. We are not aware of any
historical contamination on our properties or involving neighboring activities,
except that we currently lease property in Tacoma, Washington that is located
within a superfund site that has been the subject of regulatory action for
several years. We have not been named as a potentially liable party for
contamination associated with this superfund site, and we have no reason to
believe that we will be so named.

Environmental laws could become more stringent over time, imposing greater
compliance costs and increasing risks and penalties associated with any
violations. As a generator of hazardous materials, we are subject to financial
exposure with regard to our properties even if we fully comply with these laws.
In addition, we utilize facilities that are located in industrial areas and have
lengthy operating histories. As a consequence, it is possible that historical or
neighboring activities have affected properties we currently own, and that, as a
result, additional environmental issues may arise in the future, the precise
nature of which we cannot now predict. Any present or future noncompliance with
environmental laws or future discovery of contamination could have a material
adverse effect on our results of operations or financial condition.

Government Regulation

We manufacture some of our products under contracts with the United States
government. We manufacture other products under contracts with private third
parties who utilize our products to satisfy United States government contracts
to which they are a party. Federal acquisition regulations and other federal
regulations govern these relationships. Some of these regulations relate
specifically to the seller-purchaser relationship with the government, such as
the bidding and pricing rules. Under regulations of this type, we must observe
pricing restrictions, produce and maintain detailed accounting data, and meet
various other requirements. Other regulations relate to the conduct of our
business generally, such as regulations and standards established by the
Occupational Safety and Health Act or similar state laws and relating to
employee health and safety. In particular, regulations governing these contracts
require that we comply with federal laws and regulations, in general, or face
civil liability, cancellation or suspension of existing contracts, or
ineligibility for future contracts or subcontracts funded in whole or in part
with federal funds. In addition, loss of governmental certification (that we are
eligible for government contracted work) could cause some of our customers,
including customers in the defense industry, to reduce or curtail their
purchases from us, which could harm our business.

We have not identified any noncompliance with federal regulations affecting
these government contracts that would be material. We have identified conditions
that require attention or action. For example, as part of our environmental
compliance team efforts discussed in the previous section, we determined that
our written policies and training programs relating to employee health and
safety matters at several of our facilities required updating and revision to
ensure consistency among our United States subsidiaries

                                       19
<PAGE>

and compliance with applicable regulations. We are currently updating and
implementing these written policies and training programs. These actions are
being taken to ensure compliance with applicable laws, and not in response to
any violations identified by regulatory agencies.

Employees

As of May 31, 2000, the Company had approximately 1,200 employees, of whom
approximately 1,070 were engaged in manufacturing functions, 40 in sales and
marketing functions, 80 in administrative functions, and 10 in executive
functions. Of the employees, approximately 375 were employed by the U.S.
Aerospace Group, 530 by the European Aerospace Group, 250 by the U.S.
Electronics Group, and 45 by the corporate group. As of May 31, 2000, none of
our workforce in the United States is unionized. Certain of the European
Aerospace Group's manufacturing and engineering employees are represented by
labor unions, although all negotiations are carried out through employee work
committees. We have not experienced any work stoppages, and we believe that our
relationships with our employees are good.

Risk Factors

We have reported net losses for recent periods, and we may continue to incur net
losses, which could jeopardize our operations and decrease our stock value.

We reported a net loss of $12,869,000 for our fiscal year ended May 31, 1999 and
a net loss of $13,049,000 for our fiscal year ended May 31, 2000. We can offer
no assurance that we will achieve profitable operations or that any profitable
operations will be sustained. Our ability to achieve a profitable level of
operations in the future will depend on many factors, including our ability to
reduce the level of our debt, to assimilate our recent and potential future
acquisitions, and to finance production. Future profitability will also depend
on our ability to develop new products, the degree of market acceptance of our
existing and new products, and the level of competition in the markets in which
we operate. If we continue to incur net losses, our cash flow position could be
further damaged, our operations could be jeopardized, and our stock price could
decrease.

Our inability to generate cash if and when needed could severely impact our
ability to continue as a going concern.

Our consolidated financial statements have been prepared assuming that we will
continue as a going concern. However, our independent auditors in their most
recent report stated that Pacific Aerospace has suffered recurring losses from
operations which raise substantial doubt about our ability to continue as a
going concern. Our consolidated financial statements do not include any
adjustments that might result from the outcome of that uncertainty. If we are
not sufficiently successful in generating cash from operating activities, we may
need to sell additional common stock or other securities, or we may need to sell
assets outside the ordinary course of business. If we need to dispose of assets
outside of the ordinary course of business to generate cash, we may not be able
to realize the carrying values of those assets upon liquidation. If we are
unable to generate the necessary cash, we could be unable to continue
operations.

                                       20
<PAGE>

We need to raise additional cash or we will not be able to make our February 1,
2001 interest payment and fund our operations.

Our existing cash and credit facilities may not be sufficient to meet our
obligations as they become due during fiscal 2001. Consequently, we will need to
obtain additional cash. Our actual cash needs will depend primarily on the
amount of cash generated from or used by operations. We cannot predict
accurately the amount or timing of our future cash needs. We are required to
make our next semi-annual interest payment of approximately $3.6 million on our
11 1/4% senior subordinated notes on February 1, 2001. We do not currently have
sufficient cash to make this payment, and we do not expect to make the payment
on February 1. If we are not able to make our interest payment on February 1, we
will have a grace period of 30 additional days to make the payment before an
event of default occurs under the indenture governing our 11 1/4% senior
subordinated notes. If we cannot obtain additional cash when needed, we may be
unable to make this interest payment within the grace period or to fund our
operations and to pay all obligations as they become due or at all.

If we are unable to renew our lines of credit or obtain new lines of credit, we
may be unable to fund our operations.

Our U.S. operating lines of credit expired on September 5, 2000, and have been
extended through February 5, 2001. Due to our continued losses, our current U.S.
senior lender has decided not to renew our current revolving line of credit once
we have found a replacement lender. We are currently negotiating to obtain a
replacement revolving line of credit and possible additional term loan financing
in the U.S. Our current senior lender in the U.S. has orally expressed
willingness to extend our current revolving line of credit until a replacement
facility is in place, but we do not have a written commitment to this effect.
Our line of credit in the U.K. expired in November 2000. That line of credit has
been extended through February 28, 2001, but the effective borrowing limit has
been reduced from (Pounds)3.5 million to (Pounds)1.5 million. We have requested
renewal of that line. We may find it more difficult to renew our credit lines or
obtain new lines of credit, and we may have to pay higher interest rates,
because our recurring losses from operations raise substantial doubt about our
ability to continue as a going concern. If we are unable to renew or replace our
credit lines, we may not have enough cash to fund or sustain our current
operations or to meet our obligations as they become due, including the $3.6
million interest payment on our 11 1/4% senior subordinated notes that is due on
February 1, 2001.

We have significant debt that adversely affects our financial condition.

At May 31, 2000, our total long-term debt was approximately $69.2 million, or
approximately 48% of our total assets. We have a 1.9 to 1 debt-to-equity ratio.
In general, this ratio is an indication of our ability to service our debt. The
higher the ratio, the more difficult it will be to satisfy our debt obligations.
Unless we increase our cash flow from operations, our current debt-to-equity
ratio, coupled with continued losses, indicates that we may have difficulty
satisfying our debt obligations in the future. We incurred substantial debt and
payment obligations to finance the acquisition of our European Aerospace Group,
which was formed when we acquired Aeromet International PLC in 1998. This debt,
which consists of our senior subordinated notes, currently constitutes $63.7
million of our long-term debt and bears interest at 11.25% per year. In
addition, at May 31, 2000, our balance sheet includes approximately $3.6 million
of deferred financing costs, which are being charged off to interest expense
over the period that the related debt is expected to be outstanding. We recently
announced our intention to sell our European Aerospace Group in order to reduce
our outstanding senior subordinated notes. We do not yet know whether we can
sell Aeromet or, if it is sold, the amount of net proceeds

                                       21
<PAGE>

available to reduce our debt. Our debt could make us unable to obtain additional
financing in the future. It could also divert a significant portion of our cash
flow to principal and interest payments and away from operations and necessary
capital expenditures. Our debt has significantly increased our interest expense
and net loss, and we expect the interest expense to continue to increase our net
loss for the foreseeable future. Our debt also puts us at a competitive
disadvantage in relation to competitors with less debt and limits our
flexibility to adjust to downturns in our business or market conditions.

If we are not able to pay our debt, our lenders could accelerate the principal
owing on our debt, which we do not have the funds to pay.

If we do not generate sufficient cash flow to make our debt payments, we could
be forced to reduce or delay capital expenditures or to dispose of material
assets or operations, potentially at a substantial loss. If we were unable to
pay our debt, we might need to restructure or refinance our debt at potentially
higher rates of interest. Alternatively, we might need to seek additional equity
capital, which would dilute the value of the shares held by our existing
shareholders. We may not be able to do any of these things, or we may not be
able to do them on satisfactory terms. If we failed to make our debt payments,
the lenders would be able to declare all amounts we owe to be immediately due
and payable. If this were to occur, we would likely not have funds available to
us to pay off the debt. In addition, if we could not repay our secured debt,
secured lenders could proceed against any collateral securing that debt. The
collateral for our secured debt consists of substantially all of our assets,
including receivables, inventories, real property, personal property, and
intangible assets. If we are unable to pay our debt or other obligations,
including paying our February 1, 2001 interest payment within the grace period
ending on March 3, 2001, we may be forced to seek protection from creditors
under the bankruptcy laws.

We must comply with a number of significant debt covenants that limit our
flexibility.

The agreements that govern our debt, particularly the indenture that governs our
11 1/4% senior subordinated notes, restrict a number of our activities. Unless
we obtain consent from our lenders, we cannot dispose of or create liens on
assets or create additional indebtedness. We are not permitted to pay dividends
to shareholders or repurchase stock. Our debt covenants restrict our ability to
acquire new businesses or make investments or loans to others. We are also
subject to covenants that limit our ability to make capital expenditures, change
the business we conduct, or engage in transactions with related parties. In
addition, if there is a change of control of our company, we may be required to
repay our debt early. If we breach any of these covenants, the lenders may be
able to declare all amounts we owe to be immediately due and payable. If this
were to occur, we would likely not have funds available to us to pay off the
debt.

We may not be successful if we fail to manage our rapid growth.

We have experienced rapid growth from both operations and acquisitions. This
growth has placed and will continue to place significant demands on our
managerial, administrative, financial and operational resources. For example,
both our total number of employees and the number of our operating sites nearly
doubled as a result of acquiring our European Aerospace Group, which was formed
when we acquired Aeromet in July 1998. The size of our European Aerospace Group
has caused and will continue to cause it to have a significant impact on our
future financial results. As we grow and our business operations become more
complex, we will need to be increasingly diligent in our business decisions. To
manage our growth effectively, we must continue to improve our operational,
accounting, financial and other management processes and systems. Our U.S.
operating divisions have

                                       22
<PAGE>

had different accounting systems, which we have integrated or are in the process
of integrating. We must also continue to attract and retain highly skilled
management and technical personnel. If we do not effectively manage these
aspects of our growth, we may not succeed.

Our past and possible future acquisition strategy could negatively impact our
performance.

We have historically pursued an aggressive acquisition strategy. Although we are
currently focusing substantially all of our attention on existing operations and
on internal growth, we expect that in the future we may evaluate and pursue
potential strategic acquisitions. We have incurred substantial losses as a
result of some of our acquisitions and investments, including approximately $4.6
million in fiscal 2000 and approximately $12.7 million in fiscal 1999. We need
to better manage our acquisition strategy. This includes accurately assessing
the value, strengths and weaknesses of acquisition candidates, as well as
successfully implementing necessary changes at newly acquired subsidiaries. In
the past, our aggressive acquisition strategy has diverted management attention
from our operations, increased borrowings, disrupted product development cycles
and diluted earnings per share. If we do not successfully manage future
acquisitions, if any, our financial performance could continue to be negatively
impacted by acquisitions.

We have experienced asset impairment and may experience additional asset
impairment in the future.

We review long-lived assets and intangibles for potential impairment of value
whenever events or changes in circumstances indicate that the carrying amount of
those assets may not be recoverable. An impairment is determined by totaling the
estimated net future cash flows derived from the asset and comparing that total
to the book value of the asset. When the total of the net future cash flows is
lower than the book value, an impairment exists. The amount of the impairment is
the difference between the present value of the net future cash flows and the
book value of the asset. During the fourth quarter of fiscal 2000, due to
continuing losses and continued weakness in our business related to changes in
the commercial aerospace and transportation industries, our evaluation resulted
in the realization of a $4.6 million impairment of goodwill and a $600,000
property impairment related to our U.S. Aerospace Group. We will continue to
evaluate our assets, especially in our aerospace groups, on a quarterly basis
until such time as our divisions become consistently profitable. Our future
evaluations could result in additional impairment charges, primarily for
goodwill and for property and equipment. These possible impairment charges could
be material as our balance sheet as of May 31, 2000, includes approximately $38
million of goodwill and $44 million of property, plant and equipment.

Our European Aerospace Group has had and will continue to have a significant
impact on our business.

The acquisition of our European Aerospace Group in 1998 doubled the size of our
company. Approximately 50% of our assets and approximately 45% of our revenues
are associated with our operations in the United Kingdom. It is more difficult
for us to manage a business in the United Kingdom than our other businesses,
which are located in Washington State. The reasons for the increased difficulty
include differences in time, distance, business practices and cultural
variations. Our ownership of a business in Europe also subjects us to
regulatory, tax, and trade restrictions that we did not previously face. If we
retain ownership of our European Aerospace Group and do not effectively manage
that group, we may not be successful.

                                       23
<PAGE>

Changes in foreign currency exchange rates could negatively affect our financial
position.

Because of our European Aerospace Group, we may decide to engage in hedging
transactions to protect against losses caused by changes in the exchange rate
between the U.S. dollar and the British pound sterling. However, we have not
engaged in hedging transactions to date. Since approximately 50% of our
transactions are conducted in foreign currency, the exchange rate risk could be
material. Even if we were to engage in hedging transactions, they may not
completely offset any such losses. Our European Aerospace Group has a few
contracts that are in European currencies other than British pounds sterling, or
in U.S. dollars. We believe that the conversion of European currencies to the
Euro will not have a material adverse effect on the European Aerospace Group's
business or financial condition.

We operate in industries that are subject to cyclical downturns that could
adversely affect our revenues.

We operate in historically cyclical industries. The aerospace, defense and
transportation industries are sensitive to general economic conditions, and past
recessions have adversely affected these industries. In past years, a number of
factors have adversely affected the aerospace industry, including increased fuel
and labor costs, and intense price competition. Recently, the commercial
aircraft industry experienced a downturn in the rate of its growth due to
changing economic conditions and as a result of the ongoing financial crisis in
Asia, which caused reductions in production rates for some commercial airline
programs. The major aircraft manufacturers responded, in part, by significantly
decreasing their inventory levels. Although very recently the aerospace industry
seems to have been experiencing better results, we have not yet benefited from
the improvements. Additional cancellations or delays in aircraft orders from
customers of Boeing or Airbus could reduce demand for our products and could
have a material adverse effect on our business and financial performance.
Cyclical factors and general economic conditions could lead to a downturn in
demand for our core products and decrease our revenues.

We may fail to retain our key management and technical personnel, which could
negatively affect our business.

We believe that our ability to successfully implement our business strategy and
to operate profitably depends significantly on the continued employment of our
senior management team, led by our president, Donald A. Wright, and our ability
to retain and hire engineers and technical personnel with experience in the
aerospace and electronics industries. We have key man life insurance policies on
the life of Mr. Wright totaling $8 million. We also have an employment agreement
with Mr. Wright and several other senior managers. However, our business and
financial results could be materially adversely affected if Mr. Wright, other
members of the senior management team, or significant engineers or technical
personnel become unable or unwilling to continue in their present employment.
Our growth and future success will depend in large part on our ability to retain
and attract additional board members, senior managers and highly skilled
technical personnel with experience in the aerospace and electronics industries.
Because our U.S. operations are not located in a large metropolitan area, we may
face more difficulty in acquiring and retaining key management and technical
personnel than our competitors in major cities. Competition for such individuals
is intense, and we may not be successful in attracting and retaining them, which
could interfere with our ability to manage our business profitably.

                                       24
<PAGE>

If we do not adapt to technological change and develop new products, we could
lose customers and our revenues could decline.

The market for our products in both the aerospace and the electronics industries
is characterized by evolving technology and industry standards, changes in
customer needs, adaptation of products to customer needs, and new product
introductions. Other companies that manufacture components for the aerospace and
electronics industries from time to time may announce new products,
enhancements, or technologies that have the potential to replace or render our
existing products obsolete. Our success will depend on our ability to enhance
our current products and develop new products to meet changing customer needs,
and achieve market acceptance of those products. We view our proprietary
technology and our level of technological development as our primary strengths.
Because most of our research and development efforts are funded by customers, it
will be essential for us to continue to respond effectively to our customers'
needs. We will also need to anticipate or respond to evolving industry standards
and other technological changes on a timely and cost-effective basis. If we do
not adequately respond to these changes, we could lose customers and our
revenues could decline.

We could be subject to product liability claims and lawsuits for harm caused by
our products.

Many of our customers use our products for applications such as aircraft,
satellites, heavy trucks and other uses in which failure could have serious
consequences. We maintain product liability insurance with a maximum coverage of
$2 million. However, this insurance may not be sufficient to cover any claims
that may arise. A successful product liability claim in excess of our insurance
coverage could have a material adverse effect on our business and financial
performance.

We might have to issue a significant number of additional shares to the
investors in our Summer 2000 private placement, which would result in dilution
for our other shareholders.

Under the terms of the adjustable warrants and the vesting warrants issued in
our Summer 2000 private placement, we may be required to issue a significant
number of additional shares of common stock to the investors in that private
placement. Although the total number of shares of common stock issuable upon
exercise of the adjustable warrants and the vesting warrants cannot currently be
determined, we believe that applicable Nasdaq rules permit us to issue up to
6,621,712 shares of common stock as a result of the offering without shareholder
approval. If the number of shares issuable under the terms of the warrants would
exceed the number permitted by Nasdaq rules to be issued, we would have the
option either to seek shareholder approval to issue the excess shares or to make
cash payments to the investors in lieu of issuance of the excess shares. The
indenture governing our 11 1/4% senior subordinated notes would not currently
permit us to make cash payments in lieu of the excess shares. If we seek
shareholder approval to issue additional shares but do not receive the approval,
we would have to make such cash payments if the indenture permitted us to make
such cash payments. We would not be subject to additional penalties if, after
unsuccessfully using our best efforts to obtain shareholder approval, the
indenture prevented us from making such cash payments.

The dilution from our adjustable warrants and vesting warrants could decrease
the market price of our common stock.

To the extent that shares of common stock become exercisable under the
adjustable warrants and the vesting warrants issued in our Summer 2000 private
placement, the market price of our common stock could decrease because of
additional shares being acquired by the investors in that private placement and
sold in the market. Those investors may have an incentive to sell common stock
in the market

                                       25
<PAGE>

before the adjustable warrants fully vest because those sales could contribute
to a reduced price for our common stock. A reduced price could allow those
investors to exercise the adjustable warrants for additional shares of common
stock on subsequent vesting dates. The issuance and sale of those additional
shares could further depress the market price of the common stock and encourage
short sales of our common stock. In addition, the possibility of dilution and
decreased market price could inhibit our opportunities to obtain additional
public or private financing when and if needed or on terms acceptable to us.

Future issuances or resales of a significant number of shares of our common
stock could negatively affect the market price of our stock.

Sales of a significant number of shares of common stock in the public market or
the prospect of such sales could adversely affect the market price of our common
stock. In July 2000, we closed a private offering of common stock and warrants
in the Summer 2000 private placement. We plan to file an amended registration
statement to register the resale of up to 1,607,010 shares of common stock that
have been issued or may become issuable in connection with the Summer 2000
private placement. That registration statement will not cover shares that two of
the investors in that offering may obtain under the adjustable warrants and the
vesting warrants described in this report. The actual number of shares issuable
upon exercise of those warrants cannot be determined at this time because the
adjustment provisions of the adjustable warrants and vesting events under the
vesting warrants will determine the number of shares issuable under those
warrants. We are obligated to file another registration statement that will
permit those investors to resell the shares issuable under those warrants once
the number of shares issuable is determined. As of August 18, 2000, we have also
reserved 2,295,000 common shares for issuance under our publicly traded warrants
with an exercise price of $4.6875 per share, 3,353,948 common shares for
issuance under options outstanding under our two stock incentive plans with
exercise prices ranging from $1.50 to $4.6875 per share, 86,637 common shares
for issuance under options outstanding under our independent director stock plan
with exercise prices ranging from $1.15 to $1.90 per share, and 838,609 common
shares for issuance under other warrants with exercise prices ranging from
$1.7688 to $7.20 per share. We also have an employee stock purchase plan
permitting employees to purchase shares of common stock using payroll
deductions, subject to certain limits. Shares issued upon exercise of our
outstanding warrants or options or pursuant to the employee stock purchase plan
would be available for resale in the public markets, subject in some cases to
volume and other limitations. Any future issuance of a significant number of
common shares, or any future resales by the holders of a significant number of
common shares, or the prospect of such issuances or resales, could negatively
affect the market price of our common stock.

Our common stock could be delisted from the Nasdaq National Market System, which
could make it more difficult to buy or sell our common stock, and which would
result in our obligation to issue a substantial number of additional shares to
the investors in our Summer 2000 private placement.

Our common stock is quoted on the Nasdaq National Market System. In order to
remain listed on this market, we must meet Nasdaq's listing maintenance
standards. Because the minimum bid price for our common stock has been less than
$1.00 for over 30 consecutive trading days, or if we were unable to meet
Nasdaq's standards for any other reason, our common stock could be delisted from
the Nasdaq National Market System. The minimum bid price of our common stock has
been lower than $1.00 since November 7, 2000.

                                       26
<PAGE>

On December 21, 2000, we received a letter from Nasdaq raising a concern
regarding the continued listing of our common stock on the Nasdaq National
Market System. The letter advised us that our common stock had failed to
maintain a minimum bid price greater than or equal to $1.00 over the previous
thirty consecutive trading days, as required by applicable Nasdaq rules. As of
January 25, 2001, our common stock continued to trade below $1.00. The letter
advised us that we would be provided 90 calendar days, or until March 21, 2001,
to regain compliance with the minimum bid price rule. The letter further advised
that if, at any time before March 21, 2001, the bid price of our shares of
common stock is equal to or greater than $1.00 for a minimum of ten consecutive
trading days, Nasdaq would determine if we comply with the rule. However, if we
were unable to demonstrate compliance with the requirement on or before March
21, 2001, Nasdaq would provide us with written notification that Nasdaq had
determined to delist our common stock. We would then be entitled to request a
review of that determination.

We also received a letter from Nasdaq on December 6, 2000, raising concerns
about whether we would be able to sustain compliance with the continued listing
requirements of the Nasdaq Stock Market as a result of the "going concern"
warning that we received from our independent auditors in their last audit
report. Nasdaq requested that we provide it with certain information addressing
its concerns. We responded to that request in a timely manner, and Nasdaq has
not yet notified us as to whether we adequately addressed its concerns.

If our common stock were delisted, it would trade on the electronic bulletin
board, rather than on either the Nasdaq National Market or Small Cap Systems,
and the liquidity for our common stock would be adversely affected. In addition,
delisting would trigger the vesting of penalty shares under the vesting warrants
held by the investors in our Summer 2000 private placement, which would result
in additional dilution. For example, assuming a market price of Pacific
Aerospace common stock of $.50 per share, the closing price of our common stock
on January 25, 2001, each of the investors would receive an additional 210,000
shares. The investors would receive additional shares on each monthly
anniversary of the delisting until such time as our common stock is again listed
on the Nasdaq National Market or Small Cap Systems, or the New York or the
American Stock Exchanges or until expiration of the vesting warrants. Delisting
would also give the investors the right to accelerate the vesting of shares
under the adjustable warrants they hold, rather than having to wait for the
expiration of 60 trading days from the effective date of the registration
statement covering shares owned by the investors to obtain all of their shares
under those warrants. In the event of delisting, the number of shares issuable
to the investors would no longer be subject to the Nasdaq shareholder approval
requirement.

                                       27
<PAGE>

ITEM 2.   DESCRIPTION OF PROPERTY

Our principal executive and administrative offices are located at 430 Olds
Station Road, Wenatchee, Washington. Our headquarters building provides
approximately 18,000 square feet of office space, and is owned by the Company.
We also lease approximately 1,800 square feet of office space in Edmonds,
Washington, for a base rent of $3,260 per month, subject to annual adjustment,
under a lease that expires in 2001, and approximately 873 square feet of office
space in Wichita, Kansas, for a base rent of $928 per month, under a lease that
expires in 2001.

The location, use and approximate size of the principal owned and leased
properties where we conduct our operations as of August 18, 2000 are as follows:

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
    Group                Location             Approx.       Own/          Annual           Lease       Mortgage
                                               Area         Lease          Rent         Expiration      Balance
------------------------------------------------------------------------------------------------------------------
<S>             <C>                           <C>           <C>       <C>               <C>            <C>
    U.S.        Wenatchee, Washington            54,000     Lease            $294,000           2007      N/A
                --------------------------------------------------------------------------------------------------
 Electronics    Sequim, Washington               18,355      Own              N/A               N/A       None
                --------------------------------------------------------------------------------------------------
                Vancouver, Washington            50,000     Lease            $336,000           2009      N/A
------------------------------------------------------------------------------------------------------------------
    U.S.        Wenatchee, Washington            42,000     Lease            $213,000           2007      N/A
                --------------------------------------------------------------------------------------------------
  Aerospace     Entiat, Washington               84,000      Own              N/A               N/A     $787,000
                --------------------------------------------------------------------------------------------------
                Tacoma, Washington               21,700     Lease            $ 80,000           2008      N/A
                --------------------------------------------------------------------------------------------------
                Sedro-Woolley, Washington        94,600     Lease            $395,000           2003      N/A
                --------------------------------------------------------------------------------------------------
                Wenatchee, Washington            41,400     Lease            $166,000           2001      N/A
                --------------------------------------------------------------------------------------------------
                Wenatchee, Washington            15,000     Lease            $ 82,000           2002      N/A
                --------------------------------------------------------------------------------------------------
                Everett, Washington              11,500     Lease            $ 79,000           2003      N/A
                --------------------------------------------------------------------------------------------------
                Edmonds, Washington              10,800     Lease            $155,000           2004      N/A
------------------------------------------------------------------------------------------------------------------
  European      Sittingbourne                    54,500     Lease     (Pounds)258,000           2018      N/A
                --------------------------------------------------------------------------------------------------
  Aerospace     Sittingbourne                     7,500     Lease     (Pounds) 50,000           2005      N/A
                --------------------------------------------------------------------------------------------------
                Rochester                        37,345     Lease     (Pounds)180,000           2001      N/A
                --------------------------------------------------------------------------------------------------
                Worcester                        40,000     Lease     (Pounds)160,000           2018      N/A
                --------------------------------------------------------------------------------------------------
                Worcester                        15,000     Lease     (Pounds) 50,000           2003      N/A
                --------------------------------------------------------------------------------------------------
                Welwyn Garden City               55,000     Lease     (Pounds)333,000           2018      N/A
                --------------------------------------------------------------------------------------------------
                Birmingham                       59,000     Lease     (Pounds)236,000           2018      N/A
------------------------------------------------------------------------------------------------------------------
  </TABLE>

As of August 18, 2000, our U.S. Aerospace Group's Engineering & Fabrication
Division leased the operating facilities in Edmonds, Washington described above.
As of August 18, 2000, the division had entered into a lease that commenced in
October 2000 for approximately 10,000 square feet of space in a building in
Mountlake Terrace, Washington, at a base rent of approximately $217,000 per
year. We expect either to terminate the Edmonds lease or sublease the space.

As of August 18, 2000, we owned a building in Butler, New Jersey, where part of
our U.S. Electronics Group's Interconnect Division was previously located. In
July 1999, we moved the New Jersey operations to Wenatchee, Washington. As of
August 18, 2000, we had leased the approximately 30,000 square foot building to
a third party for a term expiring in 2003, at a rate of $11,250 per month.

In January 1999, we executed an agreement with the Port of Chelan County,
Washington, giving us an option to purchase three parcels of land at or near our
Wenatchee campus for a total of $5.4 million. We purchased the first parcel,
which was property next to our Wenatchee campus, for $853,000 in cash, on
February 2, 1999. If we exercise our options to purchase both of the remaining
two parcels,

                                       28
<PAGE>

the purchase of the second parcel would be expected to close in December 2000
and the third would be expected to close in August 2001.

We previously leased approximately 21,390 square feet of office space in
Bothell, Washington under a lease that expired in 2003, for base rent of
$295,000 per year. We subleased this space to a third party. In November 1999,
we negotiated a termination of the lease, which resulted in a reduction of the
leased space as of November 19, 1999, and complete termination of the lease as
of February 29, 2000.

ITEM 3.   LEGAL PROCEEDINGS

From time to time we are involved in legal proceedings relating to claims
arising out of operations in the normal course of business. We are not aware of
any material legal proceedings pending or threatened against the Company or any
of its properties.

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

On March 20, 2000, we held a special meeting of our shareholders. The purpose of
the meeting was to consider a proposal to approve the issuance of sufficient
shares of our Common Stock to permit conversion of our outstanding Series B
Convertible Preferred Stock. See "ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED
SHAREHOLDER MATTERS - Series B Convertible Preferred Stock." The meeting was
originally called for March 6, 2000, but was postponed until March 20, 2000,
because we did not obtain a quorum on March 6, 2000.

At the March 20 meeting, the shareholders of the Company voted to approve the
proposal, as follows:

               FOR:                 9,818,211
               AGAINST:             694,798
               ABSTAIN:             88,392
               BROKER NON-VOTES:    None

The shareholders did not vote on any other matters at the meeting.

                                       29
<PAGE>

                                    PART II

ITEM 5.   MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

Market Information, Shareholders, and Dividends

Since July 16, 1996, our Common Stock has been traded on the Nasdaq National
Market System under the symbol "PCTH", and our public warrants have been traded
on the same system under the symbol "PCTHW".  Each public warrant entitles the
holder to purchase one share of Common Stock at an exercise price of $4.6875 per
share.

The Nasdaq National Market System reported the following range of high and low
sales prices for our Common Stock and public warrants for each calendar quarter
during the period from January 1998 through May 31, 2000, which covers all of
the calendar quarters within the Company's 1999 and 2000 fiscal years:

                                              Common Stock         Warrants
    Calendar Period                         High       Low       High     Low
    1998
    First Quarter                             7.0313   4.1875    3.1250   1.1250
    Second Quarter                            6.9375   5.3125    3.0000   2.3750
    Third Quarter                             7.0000   2.7813    3.0000   1.0000
    Fourth Quarter                            3.0000   1.4375    1.0625   0.5000
    1999
    First Quarter                             2.9688   1.6875    0.8750   0.3438
    Second Quarter                            2.1875   1.5000    0.5625   0.3750
    Third Quarter                             1.7812   1.2500    0.6250   0.2500
    Fourth Quarter                            1.5000   0.5938    0.6875   0.1875
    2000
    First Quarter                             7.000    1.1250    2.4375   0.2500
    Second Quarter (April 1 - May 31, 2000)   2.7500   1.1875    1.125    0.4062

As of August 18, 2000, the closing sales price on the Nasdaq National Market
System for our Common Stock was $1.5625 per share, and for the public warrants
was $0.5625 per warrant.

We have never declared or paid cash dividends on our Common Stock. We currently
anticipate that we will retain all future earnings to fund the operations, and
we do not anticipate paying dividends on our Common Stock in the foreseeable
future. Our agreements with our principal lender and the indenture governing our
11 1/4% senior subordinated notes restrict our ability to pay dividends.

Common Stock

As of August 18, 2000, there were 1,028 holders of record of 34,261,160 shares
of Common Stock outstanding, and 18 holders of record of 2,295,000 public
warrants outstanding, based on the records maintained by our transfer agent.
Each share of outstanding Common Stock is entitled to participate equally in
dividends as and when declared by the Board of Directors, out of funds legally
available therefor, and is entitled to participate equally in any distribution
of net assets made to our common

                                       30
<PAGE>

shareholders in the event of liquidation of the Company after payment to all
creditors of the Company, subject to any preferences that may be granted to any
series of preferred stock as to dividends or liquidation. There are no
preemptive rights or rights to convert Common Stock into any other securities.
The holders of our Common Stock are entitled to one vote for each share held of
record on all matters voted upon by our shareholders and may not cumulate votes
for the election of directors. Thus, the owners of a majority of the shares of
our Common Stock outstanding may elect all of the directors of the Company, and
the owners of the balance of the shares of the Common Stock would not be able to
elect any directors of the Company.

Preferred Stock

The Company's Board of Directors has the authority to issue shares of preferred
stock in one or more series and to fix the powers, designations, preferences and
relative, participating, optional or other rights of any series of preferred
stock, including dividend rights, conversion rights, voting rights, redemption
terms, liquidation preferences, sinking fund terms and the number of shares
constituting any series, without shareholder approval, unless such approval is
required by applicable law or by the rules of any stock exchange or automated
quotation system on which securities of the Company may be listed or traded. The
rights of preferred stock could adversely affect the rights of holders of Common
Stock and the market for the Common Stock.

     Series B Convertible Preferred Stock

Preferred Stock Offering. In May and August 1998, we issued a total of 170,000
shares of Series B Convertible Preferred Stock (the "Preferred Stock") and
issued related warrants, for a total price of $17 million, in a private
placement to 17 accredited investors.

Conversion Price. Upon conversion of a share of Preferred Stock, the holder
received a number of shares of Common Stock equal to $100 divided by the then-
applicable conversion price. The conversion price of the Preferred Stock was the
lower of (a) $7.20 per share, or (b) the average of the three lowest closing bid
prices per share of the Common Stock over the 22 trading days before conversion.
The actual conversion prices ranged between $0.75 and $3.27.

Shareholder Approval. Because of Nasdaq National Market System requirements, our
agreements with the initial purchasers of the Preferred Stock prohibited us from
issuing more than 3,000,000 shares of Common Stock upon conversion of Preferred
Stock without obtaining shareholder approval for the issuance of additional
shares. Alternatively, we would have been permitted to redeem any Preferred
Stock whose conversion would cause the issuance of more than 3,000,000 shares of
Common Stock, except that the indenture governing our outstanding 11 1/4% senior
subordinated notes restricted our ability to redeem Preferred Stock. As of
January 31, 2000, 33,353 shares of Preferred Stock had been converted into
2,959,773 shares of Common Stock. On March 20, 2000, at a special meeting of
shareholders, the Company's shareholders approved the issuance of sufficient
shares of Common Stock to permit conversion of all of the outstanding Preferred
Stock.

Conversions. On March 20, 2000, immediately prior to the shareholder meeting,
136,647 shares of Preferred Stock remained outstanding. Between March 21, 2000
and June 26, 2000, these shares were converted into 7,076,775 shares of Common
Stock. In total, the 170,000 shares of Preferred Stock were converted into
10,136,548 shares of Common Stock. The issuance of the Common Stock upon
conversion of the Preferred Stock was exempt from registration under Section
3(a)(9) of the Securities Act because it was an exchange exclusively with the
holders of Preferred Stock where no commission or other remuneration was paid or
given for soliciting the exchange.

                                       31
<PAGE>

Resale. The former holders of the Preferred Stock have advised us that they
resold all but 77 shares of Common Stock into the public market, either pursuant
to a resale registration statement or in reliance on Rule 144. The conversion of
the Preferred Stock and resale of the conversion shares has had the effect of
significantly increasing the number of shares of our Common Stock in the public
market.

Warrants Issued to Preferred Shareholders. The warrants issued in connection
with the Preferred Stock may be exercised until May 15, 2001 and entitle the
holders to purchase 236,109 shares of Common Stock from the Company at an
exercise price of $7.20 per share. The Company expects that it would use the
proceeds from exercise of these warrants, when and if they are exercised,
primarily for working capital or other corporate purposes.

Warrants

As of August 18, 2000, we had outstanding warrants to purchase Common Stock as
follows:

     .    warrants to purchase 236,109 shares that (a) were issued in connection
          with the Preferred Stock offering, (b) have an exercise price of $7.20
          per share, and (c) expire on May 15, 2001;

     .    publicly traded warrants to purchase 2,295,000 shares of Common Stock,
          that (a) were issued as part of the units sold in the Company's July
          1996 registered public offering ("Units"), (b) have an exercise price
          of $4.6875 per share, and (c) expire in July 2003;

     .    warrants to purchase Units consisting of 180,000 shares of registered
          Common Stock and publicly traded warrants to purchase 180,000 shares
          of Common Stock, that (a) were issued to underwriters in the July 1996
          public offering, (b) have an exercise price of $3.75 per Unit, and (c)
          expire in July 2001;

     .    warrants to purchase a total of 501,650 shares of Common Stock issued
          to several employees and consultants of the Company, that (a) have
          exercise prices ranging from $2.00 to $9.50 per share, and (b) have
          expiration dates that range from May 2001 to February 2005; and

     .    warrants to purchase 385,000 shares that (a) were issued in connection
          with a private placement in July 2000, (b) have an exercise price of
          $2.01 per share, and (b) expire in July 2003. See "- Summer 2000
          Private Placement."

In addition, in July 2000, we issued warrants to two investors that may become
exercisable for a currently indeterminate number of shares.  See "- Summer 2000
Private Placement."

The shares of Common Stock issuable upon exercise of our outstanding warrants
are either registered for issuance or resale, available for resale under Rule
144, or subject to an obligation to register them for resale.  Exercise of these
warrants would increase the number of shares of our Common Stock available on
the public market and would dilute the interests of existing shareholders.

                                       32
<PAGE>

Summer 2000 Private Placement

Description of Summer 2000 Private Placement. On July 27, 2000, we issued
1,142,860 shares of common stock and warrants to purchase additional shares to
two accredited investors, Strong River Investments, Inc. and Bay Harbor
Investments, Inc., for gross proceeds of $2.0 million. We paid a commission to
Rochon Capital Group, Ltd. comprised of $80,000 in cash and warrants to purchase
79,150 shares of common stock, at an exercise price of $1.7688 per share,
exercisable through July 27, 2003, for representing Pacific Aerospace in this
transaction. After taking into consideration other expenses related to the
transaction, we received net proceeds at closing of $1,886,500, which we used to
pay down our U.S. credit line.

We also issued to the investors on July 27, 2000, closing warrants to purchase
an aggregate of 385,000 shares of common stock at an exercise price of $2.01 per
share, exercisable through July 27, 2003, and adjustable warrants and vesting
warrants to purchase a currently indeterminate number of shares, as described
below. The vesting dates and expiration dates contained in the warrants and the
numbers of shares issuable upon exercise of the warrants are subject to anti-
dilutive adjustments. The terms of the transaction, including the terms of the
warrants, were determined by arms length negotiations between Pacific Aerospace
and the investors.

The transaction documents also provided that upon effectiveness of the
registration statement within 60 days after the first closing, a second closing
would occur, and the investors would pay an additional $1.5 million and receive
857,140 additional shares of common stock. No additional warrants would be
issued at a second closing. The effectiveness of the registration statement
within 60 days after the first closing was the only condition to the second
closing. This condition was not satisfied, and the investors have decided not to
waive the condition. As a result, the second closing will not occur.

The private placement was made pursuant to the exemption from registration
contained in Rule 506 of Regulation D under the Securities Act based on the sale
to accredited investors in a private transaction with the purchasers
acknowledging that the securities cannot be resold unless registered or exempt
from registration under the securities laws.

Closing Warrants. On July 27, 2000, Pacific Aerospace issued the accredited
investors closing warrants to purchase an aggregate of 385,000 shares of common
stock at an exercise price of $2.01 per share. The closing warrants were
exercisable in full on the date of issuance and remain exercisable until their
expiration on July 27, 2003. These warrants are not subject to any adjustments
relating to market price, but the exercise price would be adjusted for the
issuance of common stock or common stock equivalents at a price below the
warrant exercise price while the warrants are outstanding. The exercise price
can be paid in cash, or the holder can utilize a cashless exercise provision.
The purpose of the closing warrants was to provide the investors with an
opportunity to obtain an additional return on their investment if the common
stock price exceeds $2.01 per share prior to expiration of the warrants.

Adjustable Warrants. The adjustable warrants permit the investors to acquire
additional shares of common stock for an exercise price of $.001 per share if
the market price of the Pacific Aerospace common stock does not achieve and
maintain a specific price during each of three vesting periods. Each vesting
period consists of the 20 consecutive trading days before each vesting date. The
vesting dates are the 20th, 40th and 60th trading days after the effective date
of the registration statement, subject to the right of the investors to
accelerate the vesting dates if any of the triggering events provided in the
adjustable warrants occurs. The registration statement was filed with the
Securities and Exchange Commission on August 28, 2000, but has not yet become
effective.

                                       33
<PAGE>

On each vesting date, Pacific Aerospace will determine with the investors, based
on a formula contained in the adjustable warrants, whether the warrants have
become exercisable for any warrant shares. For each vesting period, the lowest
five closing prices for Pacific Aerospace common stock during that period will
be averaged. If the average during a vesting period is less than $1.9022 per
share, the investors will be entitled to purchase additional shares in an amount
equal to: (i) one-third of the shares purchased by the investors at closing,
multiplied by (ii) the difference between $1.9022 and the average of the lowest
five closing prices for Pacific Aerospace common stock during that vesting
period, all divided by such average. The $1.9022 was derived by taking $1.75,
which was the negotiated number intended to approximate the fair market value of
the shares and warrants sold at closing, and dividing that number by .92.
Because there are three vesting periods, the formula applies on each vesting
date to one-third of the shares purchased by the investors at closing, which
limits the effect of the market prices during any single vesting period.

If the average of the lowest five closing prices for Pacific Aerospace common
stock is $1.9022 or above during a vesting period, Pacific Aerospace will not
have to issue additional shares of common stock for that vesting period. In
addition, if the average closing price of Pacific Aerospace common stock exceeds
$2.19 per share for any 20 consecutive trading days following the effective date
of the registration statement, no further vesting will occur and Pacific
Aerospace will never have to issue additional shares under the adjustable
warrants.

The investors can exercise adjustable warrants at an exercise price of $.001 per
share for fifteen trading days following each of the three vesting dates.  The
adjustable warrants expire fifteen trading days after the third vesting date.
Once the adjustable warrants expire, the investors will not be entitled to
additional shares under the adjustable warrants, even if the Pacific Aerospace
stock price decreases after that date.

If any of several triggering events occurs before the third vesting date, the
investors will have the right to accelerate the vesting of shares under the
adjustable warrants. The triggering events include: (1) the acquisition of more
than one-third of the voting securities of Pacific Aerospace; (2) the
replacement of more than one-half of the members of the Pacific Aerospace board
of directors existing as of July 27, 2000; (3) the merger, consolidation or sale
of all or substantially all of Pacific Aerospace's assets if the holders of
Pacific Aerospace securities following the transaction hold less than two-thirds
of the securities of the surviving entity or the acquirer of the assets; (4) a
transaction that would change Pacific Aerospace from a public company to a
private company; (5) the delisting of Pacific Aerospace common stock for ten
consecutive days; (6) failure to deliver certificates to the holders in a timely
manner; (7) material breach under the transaction documents; (8) failure to
obtain an effective registration statement within 180 days after the closing,
which has been extended to 200 days after the closing by the investors; or (9)
failure to maintain the registration statement effective for the required time
period.

If any of these triggering events occurs, the investors may give Pacific
Aerospace notice, and, to the extent the adjustable warrants have not already
vested, Pacific Aerospace will have to determine whether additional shares are
issuable under the warrants, using the 20 trading days before the date of the
notice as the vesting period. These provisions have several purposes. In the
event of any of the fundamental changes to Pacific Aerospace listed as items (1)
through (5), these provisions give the investors the ability to get an early
determination of whether they are entitled to additional shares under the
adjustable warrants. Item (8) above gives the investors the right to trigger
vesting by the passage of time, even if the registration statement does not
become effective. Finally, these provisions give

                                       34
<PAGE>

Pacific Aerospace an additional incentive to comply with its obligations covered
by the triggering events listed as (6) through (9) and to cure any failure to
comply.

After the number of shares issuable under the adjustable warrants is determined,
Pacific Aerospace will be required to file another registration statement to
register the resale of those shares by the investors.

Vesting Warrants.  The vesting warrants permit the investors to acquire
additional shares of common stock for an exercise price of $.001 per share if
any of two sets of triggering events occurs. The purpose of the vesting warrants
is to give Pacific Aerospace an incentive not to cause any of the triggering
events to occur prior to expiration of the vesting warrants and an incentive to
cure triggering events that occur, if they can be cured.  Each set of events has
a different formula for determining the number of shares that become issuable
under the vesting warrants.  If any of the nine triggering events listed above
occurs, the investors will be entitled to receive the number of additional
shares of common stock equal to the product of 30% of $3,500,000 divided by the
closing price of Pacific Aerospace common stock on the trading day before the
date of the event.

The vesting warrants also provide for additional shares under a different
formula if a second set of triggering events occurs.  These events include:  (1)
failure to have the registration statement effective within 60 days after the
closing; (2) other events relating to actions of Pacific Aerospace in obtaining
and maintaining an effective registration statement, and (3) the delisting of
Pacific Aerospace common stock for ten consecutive days.  If any of these events
occurs, and on each monthly anniversary thereafter until cured, the investors
will be entitled to receive a number of additional shares equal to the product
of 3% of $3,500,000 divided by the closing price of Pacific Aerospace common
stock on the trading day before the date of the event or the closing price on
the trading day before the date of the anniversary, whichever is applicable.

The figure $3,500,000 represents the amount of the entire investment the
investors would have made if the second closing had occurred, and that amount
and the 30% and 3% figures were terms of the vesting warrants negotiated with
the investors.

The vesting warrants were included in this transaction instead of Pacific
Aerospace being obligated to make cash payments to the investors upon the
occurrence or continuance of the triggering events.  Under the indenture
governing its outstanding 11 1/4% senior subordinated notes, Pacific Aerospace
would not be permitted to make cash payments to the investors.  The vesting
warrants provide comparable equity incentives.

One of the second set of triggering events occurred because the registration
statement did not become effective within 60 days after the closing.  However,
the investors waived their rights to any shares under the vesting warrants as a
result of that event. If the registration statement is not effective 180 days
after closing, which has been extended to 200 days after the closing by the
investors, shares would vest under the formula described above for the first set
of triggering events under the vesting warrants.

The vesting warrants expire five business days after the expiration of the
adjustable warrants. Once the vesting warrants expire, the investors will not be
entitled to additional shares under the vesting warrants, if one of the
triggering events occurs after the expiration date.

Limits on Shares Issuable to the Investors.  The adjustable warrants and the
vesting warrants, by their terms, cannot be exercised for a number of shares
greater than the number Pacific Aerospace may issue without shareholder approval
under applicable Nasdaq rules.  If the number of shares issuable would exceed
the number of shares permitted to be issued without shareholder approval under
applicable

                                       35
<PAGE>

Nasdaq rules, Pacific Aerospace would have two choices. First, Pacific Aerospace
could choose to make a cash payment to the investors, if and to the extent the
cash payment is permitted by Pacific Aerospace's lenders, equal to the excess
shares multiplied by the closing price of Pacific Aerospace common stock on
either the 60th day following the exercise date or the exercise date, whichever
is greater. Alternatively, Pacific Aerospace could use its best efforts to
obtain shareholder approval for the issuance of the additional shares. The
indenture governing the outstanding 11 1/4% senior subordinated notes would not
currently permit Pacific Aerospace to make the cash payments to the investors.
If this circumstance were to arise, Pacific Aerospace would most likely seek
shareholder approval to issue additional shares. If shareholder approval were
not obtained, Pacific Aerospace would be obligated to make the cash payment
described above, if and to the extent that the cash payment is permitted by the
indenture, and would be obligated to pay 18% per annum interest if such payment
were not made when due, if and to the extent that the interest payment is
permitted by the indenture. Pacific Aerospace would not be subject to additional
penalties if, after unsuccessfully using its best efforts to obtain shareholder
approval, the indenture prevented Pacific Aerospace from making cash payments to
the investors. In the event that the common stock is delisted from NASDAQ,
Pacific Aerospace would not be required to seek shareholder approval to issue
excess shares, and Pacific Aerospace does not expect that it would seek
shareholder approval for the issuance of excess shares.

The closing warrants, the adjustable warrants and the vesting warrants each
provides that an investor may not exercise a warrant to the extent that such
exercise would result in the investor beneficially owning more than 9.999% of
outstanding Pacific Aerospace common stock.

Effect of the Adjustable Warrants and the Vesting Warrants.  The following table
outlines the number of common shares that would be issuable under the adjustable
warrants at several hypothetical adjustment prices.  The table also sets forth
the total number of shares the investors would beneficially own at such
hypothetical adjustment prices and the percentage that such shares would
constitute of the resulting outstanding common stock of Pacific Aerospace,
assuming the investors had not purchased or sold any Pacific Aerospace
securities. Each of the investors, Strong River and Bay Harbor, would own half
of the securities shown below.

The closing price of Pacific Aerospace common stock on July 26, 2000, the
trading day immediately before the closing of this transaction, was $1.5938 per
share.  During calendar year 1999, the closing price of Pacific Aerospace common
stock ranged from a low of $0.5938 to a high of $2.9688 per share.  During
calendar year 2000, the closing price of the common stock ranged from a low of
$0.3438 to a high of $7.00 per share.

                                       36
<PAGE>

<TABLE>
<CAPTION>
                                              Shares Issuable                      Total Shares     Total Shares as
Hypothetica                 Shares Issuable        Under        Shares Issuable     Issued and       a Percent of
Adjustment   Shares Issued   Under Closing       Adjustable      Under Vesting      Issuable to       Outstanding
Price/(1)/     at Closing       Warrants       Warrants/(1)/     Warrants/(2)/       Investors        Stock/(3)/
 ----------    ----------       --------       ------------      --------------      ---------         ---------
<S>          <C>            <C>               <C>               <C>               <C>              <C>
  $0.25        1,142,860        385,000          7,552,814              0             9,080,674         20.90%
  $0.50/(4)/   1,142,860        385,000          3,204,977              0             4,732,837         12.10%
  $0.60        1,142,860        385,000          2,480,338              0             4,008,198         10.44%
  $0.75        1,142,860        385,000          1,755,698              0             3,283,558          8.72%
  $1.00        1,142,860        385,000          1,031,058              0             2,558,918          6.93%
  $1.25        1,142,860        385,000            596,275              0             2,124,135          5.82%
  $1.50        1,142,860        385,000            304,419              0             1,832,279          5.06%
  $1.75        1,142,860        385,000             99,379              0             1,627,239          4.52%
  $2.00        1,142,860        385,000                  0              0             1,527,860          4.26%
  $3.00        1,142,860        385,000                  0              0             1,527,860          4.26%
</TABLE>

___________________

/(1)/ Under the adjustable warrants, the adjustment price would be based on the
      average of the lowest five closing prices for Pacific Aerospace common
      stock during the 20 consecutive trading days before each of three vesting
      dates. This table assumes that the hypothetical adjustment price is the
      same for each of these vesting periods.

/(2)/ If triggering events occur under the vesting warrants, the number of
      shares issuable under the vesting warrants would depend on the type and
      duration of the triggering event and the price of Pacific Aerospace common
      stock. This table assumes that no shares are issuable under the vesting
      warrants.

/(3)/ Based on 34,367,246 shares of common stock outstanding on January 25,
      2001, plus the shares issuable to investors under the adjustable warrants,
      vesting warrants and closing warrants shown above.

/(4)/ Closing price of Pacific Aerospace common stock on January 25, 2001.


Spring 2000 Private Placement

In March 2000, we closed a private offering of 1,598,000 shares of Common Stock
to 26 accredited investors for net offering proceeds of $4,058,920 in cash.  The
transaction was exempt from registration under Rule 506 of Regulation D under
the Securities Act based on the sale to accredited investors in a private
transaction with the purchasers acknowledging that the securities cannot be
resold unless registered or exempt from registration under the securities laws.
We subsequently filed a registration statement to register the resale of the
shares sold in the offering.  The registration statement was declared effective
on May 10, 2000.

Exchange of Common Stock for Senior Subordinated Notes

In March, 2000 we exchanged an aggregate of $11.3 million in original principal
amount of our 11 1/4% senior subordinated notes (the "Notes") for a total of
2,902,806 shares of Common Stock in four

                                       37
<PAGE>

exchange transactions (the "Exchanges"). The Exchanges were each conducted with
the same noteholder, Post Advisory Group, Inc. The issuance of the Common Stock
to the noteholder in the Exchanges was exempt from registration under Section
3(a)(9) of the Securities Act because the exchange was exclusively with the
noteholder and no commission or other remuneration was paid or given for
soliciting the exchange. We believe that the noteholder resold all of the Common
Stock issued in the Exchanges into the public market prior to April 1, 2000. The
effect of the Exchanges was to reduce the outstanding principal amount of our
Notes from $75 million to $63.7 million, which substantially reduced the semi-
annual interest payment on the Notes from approximately $4.2 million to $3.6
million. The exchanges resulted in a cumulative net of tax extraordinary gain of
$703,000.

Warrant Exercise

On February 8, 2000, David A. Noyes & Co. purchased 25,000 shares of common
stock by exercising a warrant and paying us the aggregate exercise price of
$86,250 in cash. The sale was a private offering exempt from registration under
section 4(2) of the Securities Act based on a single purchaser acquiring shares
from us and acknowledging that the shares cannot be resold unless registered or
exempt from registration under the securities laws. The shares were covered by a
resale registration statement (File No. 333-41407) and were resold by the
purchaser shortly after exercise. The purchaser had acquired its warrant from us
in June, 1997, in connection with a financial services agreement.

Issuance of Warrants

On April 17, 2000, we issued Continental Capital & Equity Corporation common
stock purchase warrants that entitle Continental to purchase a total of 200,000
shares of common stock, with 50,000 shares exercisable at $3.50 per share,
50,000 shares exercisable at $5.50 per share, 50,000 shares exercisable at $7.50
per share, and 50,000 shares exercisable at $9.50 per share. Continental has the
right, through April 17, 2003, to require us to file a registration statement
covering resale of the 200,000 shares issuable upon exercise of the warrants.
The warrants are exercisable until the earlier of April 17, 2003, or 12 months
after the effective date of that registration statement. The warrants were
issued in partial consideration for Continental providing us public relations
and investor relations services for one year beginning in April, 2000. The
issuance of the warrants was a private offering exempt from registration under
section 4(2) of the Securities Act because Continental represented that it
acquired the warrants for investment purposes, with no present intention of
distribution and acknowledged that the warrants, and any shares issuable upon
exercise of the warrants, cannot be resold unless registered or exempt from
registration under the securities laws.

Registration Rights

We are obligated to register the resale of the following shares:

CCEC.  Continental Capital & Equity Corporation has the right, through April 17,
2003, to require us to file a resale registration statement with respect to up
to 200,000 shares issuable upon exercise by Continental of warrants held by
them.

Summer 2000 Private Placement.  The Company is obligated to file one or more
resale registration statements to register the resale of the shares issued or
issuable in connection with the Summer 2000 private placement. We filed a
registration statement in August, 2000, which we expect will cover up to
1,607,010 of these shares.  The shares issued or issuable in connection with the
Summer 2000 private placement include:

                                       38
<PAGE>

     .    1,142,860 shares issued at the closing;

     .    up to 385,000 shares issuable upon exercise of warrants held by the
          investors; and

     .    a currently indeterminate number of shares issuable upon exercise of
          additional warrants held by the investors.

In addition, the Company is obligated to register for resale up to 79,150 shares
issuable upon exercise of warrants held by the placement agent in the Summer
2000 private placement.

Nasdaq

Our common stock is quoted on the Nasdaq National Market System.  In order to
remain listed on this market, we must meet Nasdaq's listing maintenance
standards. Because the minimum bid price for our common stock has been less than
$1.00 for over 30 consecutive trading days, or if we were unable to meet
Nasdaq's standards for any other reason, our common stock could be delisted from
the Nasdaq National Market System.  The minimum bid price of our common stock
has been lower than $1.00 since November 7, 2000.

On December 21, 2000, we received a letter from Nasdaq raising a concern
regarding the continued listing of our common stock on the Nasdaq National
Market System.  The letter advised us that our common stock had failed to
maintain a minimum bid price greater than or equal to $1.00 over the previous
thirty consecutive trading days, as required by applicable Nasdaq rules.  As of
January 8, 2001, our common stock continued to trade below $1.00.  The letter
advised us that we would be provided 90 calendar days, or until March 21, 2001,
to regain compliance with the minimum bid price rule.  The letter further
advised that if, at any time before March 21, 2001, the bid price of our share
of common stock is equal to or greater than $1.00 for a minimum of ten
consecutive trading days, Nasdaq would determine if we comply with the rule.
However. if we were unable to demonstrate compliance with the requirement on or
before March 21, 2001, Nasdaq would provide us with written notification that
Nasdaq had determined to delist our common stock.  We would then be entitled to
request a review of that determination.

We also received a letter from Nasdaq on December 6, 2000, raising concerns
about whether we would be able to sustain compliance with the continued listing
requirements of the Nasdaq Stock Market as a result of the "going concern"
warning that we received from our independent auditors in their last audit
report.  Nasdaq requested that we provide it with certain information addressing
its concerns.  We responded to that request in a timely manner, and Nasdaq has
not yet notified us as to whether we adequately addressed its concerns.

If our common stock were delisted, it would trade on the electronic bulletin
board, rather than on either the Nasdaq National Market or Small Cap Systems,
and the liquidity for our common stock would be adversely affected.  In
addition, delisting would trigger the vesting of penalty shares under the
vesting warrants held by the investors in our Summer 2000 private placement,
which would result in additional dilution.  For example, assuming a market price
of Pacific Aerospace common stock of $.50 per share, the closing price of our
common stock on January 25, 2001, each of the investors would receive an
additional 210,000 shares.  The investors would receive additional shares on
each monthly anniversary of the delisting until such time as our common stock is
again listed on the Nasdaq National Market or Small Cap Systems, or the New York
or the American Stock Exchanges or until expiration of the vesting warrants.
Delisting would also give the investors the right to accelerate the vesting of
shares under the adjustable warrants they hold, rather than having to wait for
the expiration of 60 trading days

                                       39
<PAGE>

from the effective date of the registration statement covering shares owned by
the investors to obtain all of their shares under those warrants. In the event
of delisting, the number of shares issuable to the investors would no longer be
subject to the Nasdaq shareholder approval requirement.

Indemnification

The Company agreed to indemnify the holders of the Preferred Stock and the
investors in the Summer 2000 private placement, and those holders and investors
agreed to indemnify the Company, against certain liabilities under the
Securities Act.  Insofar as indemnification for liabilities arising under the
Securities Act may be permitted directors, officers and controlling persons of
the Company pursuant to the foregoing provisions, or otherwise, we have been
advised that, in the opinion of the SEC, such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable.

Anti-Takeover Laws

The Company, as a Washington corporation, is subject to certain provisions of
Washington law regarding significant business transactions and fair price
restrictions.  These provisions may have the effect of delaying or deterring a
hostile takeover of the Company.

Washington's "Significant Business Transactions" statute (Chapter 23B.19 of the
Washington Business Corporation Act) applies to public companies that are
incorporated under Washington law.  The statute prohibits, subject to certain
exceptions, a corporation from entering into any "significant business
transactions" with an "Acquiring Person" (defined generally as a person who or
an affiliated group that beneficially owns 10% or more of the outstanding voting
securities of a corporation) for a period of five years after such person or
affiliated group becomes an Acquiring Person unless the transaction or share
acquisition made by the Acquiring Person is approved prior to the share
acquisition by a majority of the target corporation's directors.  In addition,
this statute prohibits a corporation subject thereto from entering into a
significant business transaction with an Acquiring Person unless the
consideration to be received by the corporation's shareholders in connection
with the proposed transaction satisfies the "fair price" provisions set forth in
the statute.

Transfer Agent and Registrar

The Transfer Agent and Registrar for our Common Stock and publicly traded
warrants is Interwest Transfer Co., Inc.

                                       40
<PAGE>

ITEM 6.   SELECTED FINANCIAL DATA

The following selected financial data presents selected historical financial
data of the Company as of and for the years ended May 31, 1996, 1997, 1998,
1999, and 2000, and is derived from the Company's audited financial statements.
This data should be read in conjunction with the Company's Financial Statements
and Notes thereto, the Independent Auditors' Report, and Management's Discussion
and Analysis of Financial Condition and Results of Operations. The independent
auditors' report contains an explanatory paragraph that states that the
Company's recurring losses from operations raise substantial doubt about our
ability to continue as a going concern. Our consolidated financial statements
and the following selected financial data do not include any adjustments that
might result from the outcome of that uncertainty.

<TABLE>
<CAPTION>
                                                                   Years Ended May 31,
                                      ---------------------------------------------------------------------------
                                                   (in thousands, except percentage and per share data)
                                               1996           1997           1998            1999           2000
                                               ----           ----           ----            ----           ----
<S>                                     <C>            <C>            <C>            <C>             <C>
Statement of Operations Data:
    Net sales/(1)/......................       $20,725        $34,175        $54,099        $107,366       $112,694
    Cost of sales.......................        16,439         25,969         39,487          86,302         92,063
                                               -------        -------        -------        --------       --------
    Gross profit........................         4,286          8,206         14,612          21,064         20,631
    Operating expenses..................         4,869          6,259          9,872          22,039         24,533
                                               -------        -------        -------        --------       --------
    Income (loss) from operations.......          (583)         1,947          4,740            (975)        (3,902)
    Net interest (expense)..............          (498)          (384)          (755)         (8,140)        (9,862)
    Other income (expense)..............            15            169           (853)         (6,393)            33
                                               -------        -------        -------        --------       --------
    Income (loss) before taxes and
    extraordinary item..................        (1,066)         1,732          3,132         (15,508)       (13,731)
    Extraordinary item, net of tax......             -              -              -               -            703
    Income taxes benefit (expense)......            67            (50)           482           2,639            (21)
                                               -------        -------        -------        --------       --------
    Net income (loss)...................       $  (999)       $ 1,682        $ 3,614        $(12,869)      $(13,049)
                                               -------        -------        -------        --------       --------
    Net income (loss) per share:
     Basic..............................          (.16)           .18            .29            (.74)          (.59)
     Diluted............................          (.16)           .17            .27            (.74)          (.59)
    Shares used in computation of
    income (loss) per share:
     Basic..............................         6,209          9,500         12,486          17,359         21,955
     Diluted............................         6,209         10,036         13,606          17,359         21,955
Other Financial Data:
   Adjusted EBITDA/(2)/.................       $   288        $ 3,305        $ 6,944        $ 10,669       $  9,004
   Adjusted EBITDA margin/(3)/..........           1.4%           9.7%          12.8%            9.9%           8.0%
   Depreciation, amortization, and
   impairment of long-lived assets......       $   871        $ 1,358        $ 2,204        $ 11,644       $ 12,906
   Capital expenditures.................         1,293          2,739         10,290           8,281          4,867
</TABLE>

                                       41
<PAGE>

<TABLE>
<CAPTION>
                                                                       At May 31,
                                      --------------------------------------------------------------------------
                                                                     (in thousands)

                                                 1996          1997          1998            1999           2000
                                                 ----          ----          ----            ----           ----
<S>                                          <C>           <C>          <C>           <C>             <C>
Balance Sheet Data:
  Cash and cash equivalents...........        $   725       $ 3,048       $11,461        $  8,134       $  2,154
  Working capital.....................            952        13,090        25,599          38,329         29,181
  Total assets........................         27,649        35,752        78,580         158,727        143,582
  Long-term debt (including current
   portion)...........................          6,404         4,233        11,233          83,410         70,528
  Shareholders' equity................         12,539        25,619        56,142          54,019         49,768
</TABLE>


----------------------

/(1)/  The increases in net sales are attributable to acquisitions by the
       Company and internal growth. See "Description of Business" and
       "Management's Discussion and Analysis of Financial Condition and Results
       of Operations."
/(2)/  "Adjusted EBITDA" represents income (loss) from operations plus
       depreciation, amortization, and non-cash asset impairment expense.
       Adjusted EBITDA should not be construed as an alternative to (i) net
       income, as defined by generally accepted accounting principles, as an
       indicator of the Company's operating performance or (ii) cash flow, as
       defined by generally accepted accounting principles, as a measure of
       liquidity. The Company reports Adjusted EBITDA as a commonly used cash
       flow capacity measure by financial institutions, including holders of the
       Company's senior subordinated notes. Generally, the Company considers
       Adjusted EBITDA as a measure of cash flow capacity to fund interest
       expense, principal payments on debt, working capital needs and capital
       expenditures. This measure may not be comparable to similarly titled
       measures reported by other companies. The adequacy and historical trend
       of Adjusted EBITDA to support funding requirements is an indication to
       our management whether cash sources in addition to Adjusted EBITDA may be
       required to support ongoing operations.
/(3)/  "Adjusted EBITDA margin" represents Adjusted EBITDA as a percent of net
       sales. We use Adjusted EBITDA margin as a measure to evaluate better our
       Adjusted EBITDA capacity trends.

                                       42
<PAGE>

ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
          RESULTS OF OPERATIONS

--------------------------------------------------------------------------------
 This section and the "Description of Business" section of this Form 10-K
 contain "forward-looking statements." These forward-looking statements are not
 guarantees of the Company's future performance. They are subject to risks and
 uncertainties related to business operations, some of which are beyond the
 Company's control. Any of these risks or uncertainties may cause actual results
 or future circumstances to differ materially from the forward-looking
 statements set forth in this section under the captions "Overview" and
 "Liquidity and Capital Resources," and in "Description of Business" under each
 of the captions in that section.
--------------------------------------------------------------------------------

Overview
--------

We have historically been an active consolidator of companies, and our results
of operations have been substantially affected by acquisitions.  We have
acquired and integrated twelve companies since 1990.  See "Description of
Business - Corporate History." These acquisitions, as well as internal growth in
our existing and acquired businesses, have resulted in substantial increases in
net sales.  Our operating expenses and margins and other expenses also have been
affected by certain expenses directly associated with the acquisitions and
related capital raising transactions.  We have experienced substantial increases
in all other expense categories as a result of the increases in our operations.
A portion of these expenses is attributable to the assimilation of acquired
operations into our existing businesses.

In July 1998, we acquired Aeromet International PLC ("Aeromet"), which forms the
core of our European Aerospace Group.  Aeromet is a manufacturer of magnesium
and aluminum precision sand and investment castings, and of titanium and
aluminum formed sheet products, with five locations in England.  The Aeromet
acquisition has had a significant effect on our operations and on comparisons of
income, expense, and balance sheet items in periods after July 1998.  Our
financial results for fiscal 1999 included ten months of operations of Aeromet.

Substantially all of our revenues are generated by sales to customers in the
commercial aerospace, defense, electronics, medical, energy, telecommunications,
and transportation industries, with commercial aerospace and defense industry
sales being the most significant.  The commercial aerospace and defense
industries are cyclical in nature and subject to changes based on general
economic conditions, and on commercial airline industry, defense and government
spending.  See "Description of Business - Industry Overview" and "- Risk
Factors."

Our operations focus on developing, manufacturing and marketing high performance
electronics and metal components and assemblies.  Our electronics products are
characterized by relatively low volumes and high margins.  Customer product
demand varies significantly depending upon the application and industry served.
Our electronics products are highly engineered, complex components that
incorporate our patented and proprietary manufacturing processes.  In
comparison, volumes have historically been higher and margins lower for our
metals products. Customer product demand for our metal products is generally
associated with order cycles that are more variable, such as commercial aircraft
and heavy trucking.  Since 1998, cutbacks by aircraft manufacturers have
adversely affected demand for the products manufactured by our U.S. and European
Aerospace Groups.  The recent downturn in the heavy trucking industry has led to
reduced demand for several products made by the Casting Division of our U.S.
Aerospace Group.  Products incorporating both electronics and metal parts are
expected to generate margins closer to electronics product margins.  As a result
of margin differences, changes in product mix among our electronics, assembled
and metals products can be expected to affect our overall margins.

                                       43
<PAGE>

The Company's sales are not subject to significant seasonal fluctuations.
However, production and resulting sales are subject to the number of working
days in any given period.  Results for various periods may vary materially due
to the number of working days available in any period.

Management believes that the Company's operations for the periods discussed have
not been adversely affected by inflation.

Results of Operations
---------------------

For an understanding of the significant factors that influenced our performance
during the past three fiscal years, the following discussion should be read in
conjunction with our consolidated financial statements presented in this Form
10-K.

The following table sets forth certain of our historical statement of operations
data for the periods indicated, expressed in dollars (in thousands) and as a
percentage of net sales.

<TABLE>
<CAPTION>
                                                                         Years Ended May 31,

                                 ---------------------------------------------------------------------------------------------------
                                       1996                  1997                1998               1999                 2000
                                 -------------------  -----------------  ------------------- ------------------ -------------------
<S>                              <C>        <C>      <C>        <C>       <C>        <C>    <C>         <C>     <C>        <C>
Net sales......................   $ 20,725   100.0%   $ 34,175   100.0%    $ 54,099   100.0% $ 107,366   100.0%  $ 112,694  100.0%
Cost of sales..................     16,439    79.3    $ 25,969    76.0       39,487    73.0     86,302    80.4      92,063   81.7
                                 -------------------  -----------------  ------------------- ------------------ -------------------
Gross profit...................      4,286    20.7       8,206    24.0       14,612    27.0     21,064    19.6      20,631   18.3
Operating expenses.............      4,869    23.5       6,259    18.3        9,872    18.2     22,039    20.5      24,533   21.8
                                 -------------------  -----------------  ------------------- ------------------ -------------------
Income (loss) from operations..       (583)   (2.8)      1,947     5.7        4,740     8.8       (975)   (0.9)     (3,902)  (3.5)
Net interest expense...........       (498)   (2.4)       (384)   (1.1)        (755)   (1.4)    (8,140)   (7.6)     (9,862)  (8.8)
Other income (expense).........         15     0.0         169     0.5         (853)   (1.6)    (6,393)   (6.0)         33    0.0
Extraordinary item.............          -       -           -       -            -       -          -       -         703    0.6
Income tax benefit(expense)....         67     0.3         (50)    0.1          482     0.9      2,639     2.5         (21)   0.0
                                 -------------------  -----------------  ------------------- ------------------ -------------------
Net income (loss)..............   $   (999)   (4.9)%  $  1,682     4.9%    $  3,614     6.7% $ (12,869)  (12.0)% $ (13,049) (11.6)%
                                 ===================  =================  =================== ================== ===================
Adjusted EBITDA/(1)/...........   $    288     1.4%   $  3,305     9.7%    $  6,944    12.8% $  10,669     9.9%  $   9,004    8.0%
                                 ===================  =================  =================== ================== ===================
</TABLE>

/(1)/ "Adjusted EBITDA" represents income (loss) from operations plus
depreciation, amortization, and non-cash asset impairment expense.  Adjusted
EBITDA should not be construed as an alternative to (i) net income, as defined
by generally accepted accounting principles, as an indicator of the Company's
operating performance or (ii) cash flow, as defined by generally accepted
accounting principles, as a measure of liquidity.  The Company reports Adjusted
EBITDA as a commonly used cash flow capacity measure by financial institutions,
including holders of the Company's senior subordinated notes.  Generally, the
Company considers Adjusted EBITDA as a measure of cash flow capacity to fund
interest expense, principal payments on debt, working capital needs and capital
expenditures.  This measure may not be comparable to similarly titled measures
reported by other companies.  The adequacy and historical trend of Adjusted
EBITDA to support funding requirements is an indication to our management
whether cash sources in addition to Adjusted EBITDA may be required to support
ongoing operations.

Year Ended May 31, 2000 Compared to Year Ended May 31, 1999

Net Sales.  Net sales increased by $5.3 million, or 5.0%, to $112.7 million for
fiscal 2000 from $107.4 million in fiscal 1999.  The increase in revenue was
primarily due to a full year of operations in our European Aerospace Group (a
$4.1 million increase) and the addition of our U.S. Aerospace Group's
Engineering & Fabrication Division (a $6.7 million increase), offset by reduced
sales volume in our U.S. Aerospace Group's Machining Division (a $7.1 million
decrease).  The Machining Division continues to be affected by decreases in
production of model 747 aircraft and inventory minimization initiatives at
Boeing, the division's largest customer. Boeing's inventory minimization
initiatives have resulted in decreased orders from Boeing while Boeing used up
its existing inventory, and are expected

                                       44
<PAGE>

to continue to affect the Company because Boeing plans to order parts when
needed and not to build up an inventory of parts.

Gross Profit.  Our gross profit as a percentage of sales for the year was 18.3%,
compared to 19.6% in fiscal 1999.  This decrease was primarily due to low sales
volumes in our aerospace and transportation production facilities.  These
facilities traditionally have a high amount of fixed costs which, when coupled
with low sales volumes, cause the gross profit to decrease.  Pricing pressure
from customers has also led to low overall gross profit in the aerospace and
transportation markets.

Operating Expenses.  Operating expenses increased by $2.5 million, or 11.3%, to
$24.5 million for fiscal 2000 from $22.0 million in fiscal 1999.  This increase
in operating expenses is primarily due to a full year of operations in our
European Aerospace Group and the addition of our U.S. Aerospace Group's
Engineering & Fabrication Division.  Operating expenses include non-cash charges
related to the impairment of long-lived assets, primarily goodwill, of $5.2
million primarily related to our U.S. Aerospace Group in fiscal 2000 and $4.9
million primarily related to our U.S. Electronics Group in fiscal 1999.  We
review long-lived assets and identifiable intangibles for potential impairment
of value whenever events or changes in circumstances indicate that the carrying
amount of those assets may not be recoverable.  During the fourth quarter of
fiscal 2000, due to continuing losses and continued weakness in the commercial
aerospace and transportation industries, our evaluation resulted in the
realization of a  $4.6 million impairment of goodwill and a $600,000 property
impairment related to our U.S. Aerospace Group. We will continue to evaluate the
Company's assets, especially in our U.S. Aerospace Group, on a quarterly basis
until such time as our divisions become consistently profitable.  Our future
evaluations could result in additional impairment charges for goodwill and for
property and equipment.

Approximately $2.4 million of the $4.6 million goodwill impairment related
directly to goodwill associated with the Nova-Tech Engineering acquisition,
which was acquired by our Engineering & Fabrication Division on May 1, 2000.  In
April of 1999 we entered into an operating agreement with Nova-Tech Engineering,
Inc.  We provided consultation and assistance with operations, strategic
planning, sales, customers and suppliers, products, employees, accounting and
management.  We also entered into two loan agreements with Nova-Tech under which
we loaned $2.5 million to Nova-Tech for working capital.  Periodically, from
April 1999 until the acquisition date, May 1, 2000, we reviewed the
collectibility of the amounts due from Nova-Tech.  Based upon projections of
future cash flows completed by us in February 2000, we determined that Nova-Tech
would have sufficient future cash flows to repay the loan amounts due to us, but
that fees due to us under the operating agreement, $10,000 per month, were not
going to be collectible.  We did not record the income and related bad debt
associated with the operating agreement fee, as we believed the amounts were
immaterial.  Also, based upon our cash flow projections completed in February of
2000, we terminated our original purchase agreement with Nova-Tech, which called
for a purchase price of approximately $7.0 million.  We renegotiated a purchase
price for Nova-Tech of $50,000 plus forgiveness of the debt owed us.  This new
purchase price resulted in goodwill being recognized on the purchase of
approximately $3.9 million.  Subsequent to acquisition, during our budgeting
process, we prepared a revised forecast based on our current assessment of Nova-
Tech's future business prospects.  This revised forecast took into consideration
recently cancelled and postponed projects.  The revised forecast estimated
future cash flows, undiscounted, of $3.8 million, significantly lower than what
we had previously estimated future cash flows to be.  Since this amount was less
than our carrying amount of Nova-Tech goodwill, $3.9 million, an impairment was
determined to exist.  The revised forecast estimated the present value of future
cash flows to be $1.5 million.  Based upon this, we recognized an impairment
charge of $2.4

                                       45
<PAGE>

million to reduce the carrying value of Nova-Tech goodwill from approximately
$3.9 million to approximately $1.5 million.

Adjusted EBITDA.   Adjusted EBITDA decreased by $1.7 million, or 15.9%, to $9.0
million for fiscal 2000 from $10.7 million in fiscal 1999.  As a percentage of
net sales, Adjusted EBITDA decreased to 8.0% in fiscal 2000 from 9.9% in fiscal
1999.  The decrease in Adjusted EBITDA as a percentage of net sales during this
period was primarily attributable to decreased gross profit due to the decline
in commercial aerospace and transportation net sales.

Net Interest Expense.   Net interest expense increased by $1.7 million, or
21.2%, to $9.9 million for fiscal 2000 from $8.1 million in fiscal 1999.  This
increase was primarily due to a full year of interest expense associated with
our 11 1/4% senior subordinated notes, and higher average outstanding balances
on our revolving lines of credit.

Other Income (Expense).   Other income (expense) represents unusual and non-
operational income and expense for the period.  Other expense decreased by $6.4
million, from $6.4 million expense in fiscal 1999 to other income of $33,000 in
fiscal 2000.  Prior year other expense was primarily composed of a non-cash
charge related to the write down of our investment in unregistered common stock
of Orca Technologies, Inc.

Extraordinary Item.  In March 2000, we exchanged an aggregate of $11.3 million
in original principal amount of our 11 1/4% senior subordinated notes for a
total of 2,902,806 shares of common stock.  This exchange was accounted for as
an early extinguishment of debt, and as such, a net of tax gain of $703,000 has
been recorded in the accompanying financial statements as an extraordinary item.

Net Income.   Net income decreased by $180,000, to a net loss of $13.0 million
for fiscal 2000 from a net loss of $12.9 million in 1999, primarily as a result
of the factors discussed above.

Year Ended May 31, 1999 Compared to Year Ended May 31, 1998

Net Sales.   Net sales increased by $53.3 million, or 98.5%, to $107.4 million
for fiscal 1999 from $54.1 million in fiscal 1998.  The significant increase in
net sales for fiscal 1999 from fiscal 1998 included a significant net sales
contribution from Aeromet (a $52.8 million increase) and an increase in
electronic products in aerospace, satellite and weapons systems (a $3.5 million
increase), offset by a decrease in commercial aerospace and transportation net
sales (a $3.0 million decrease).  The commercial aerospace industry net sales
decrease was primarily attributable to decreases in production of certain
aircraft models and inventory minimization initiatives at Boeing.

We completed the Aeromet acquisition in July 1998.  This acquisition expanded
our operations to the European aerospace and defense markets, as well as adding
to our core competencies in casting and forming.  See "Description of Business -
Products, Processes and Markets - European Aerospace Group." Accordingly, net
sales for fiscal 1999 also included ten months of operations of Aeromet,
contributing $52.8 million in net sales.

Gross Profit.   Gross profit increased by $6.5 million, or 44.5%, to $21.1
million for fiscal 1999 from $14.6 million in fiscal 1998.  As a percentage of
net sales, gross profit decreased to 19.6% in fiscal 1999 from 27.0% in fiscal
1998. This percentage decrease was primarily attributable to three factors.
First, the addition of Aeromet caused consolidated average margins to be lower
since casting segment gross profits have been historically lower, generally in
the 18% to 22% range (gross profits on

                                       46
<PAGE>

Aeromet net sales for fiscal 1999 were 20%). Second, commercial aerospace net
sales decreased during fiscal 1999; and third, we recorded approximately $2.2
million in unusual adjustments to inventories, which reduced gross profit margin
by 2.1% for fiscal 1999.

Operating Expenses.   Operating expenses increased by $12.2 million, or 123.2%,
to $22.0 million for fiscal 1999 from $9.9 million in fiscal 1998.  The Aeromet
acquisition added $2.7 million, corporate operational costs added $2.5 million,
$2.2 million was attributable to general cost increases in operating businesses,
and $4.9 million was due to non-cash impairment of long-lived assets, primarily
goodwill.

Adjusted EBITDA.   Adjusted EBITDA increased by $3.7 million, or 53.6%, to $10.7
million for fiscal 1999 from $6.9 million in fiscal 1998.  As a percentage of
net sales, Adjusted EBITDA decreased to 9.9% in fiscal 1999 from 12.8% in fiscal
1998.  The decrease in Adjusted EBITDA as a percentage of net sales during this
period was primarily attributable to $2.2 million in unusual adjustments to
inventories recorded during the year and the decreased gross profit due to the
decline in commercial aerospace net sales.

Net Interest Expense.   Net interest expense increased by $7.4 million, or
978.1%, to $8.1 million for fiscal 1999 from $755,000 in fiscal 1998.  This
increase was primarily due to our financing of the Aeromet acquisition in July
1998 with the issuance of $75.0 million of 11 1/4% senior subordinated notes (a
$7.7 million increase in interest expense and the associated amortization of
issuance costs).

Other Income (Expense).   Other income (expense) represents unusual and non-
operational income and expense for the period.  Other expense increased to $6.4
million in fiscal 1999 from $853,000 in fiscal 1998.  This increase of $5.5
million was due principally to a $7.8 million write down of our investment in
unregistered common stock of Orca Technologies, Inc.

Net Income.   Net income decreased $16.5 million, to a $12.8 million loss for
fiscal 1999 from a $3.6 million profit in 1998, primarily as a result of the
factors discussed above.

Year Ended May 31, 1998 Compared to Year Ended May 31, 1997

Net Sales.   Net sales increased by $19.9 million, or 58%, to $54.1 million for
fiscal 1998 from $34.2 million in fiscal 1997.  The significant increase in net
sales for fiscal 1998 from fiscal 1997 included increases in both commercial
aerospace industry net sales (an $11.3 million increase) and defense industry
net sales (a $3.5 million increase).  The commercial aerospace industry net
sales increase was primarily attributable to increases in production at Boeing
and the related increase in demand from that customer for our precision cast and
machined products.  The defense industry net sales increase was primarily
attributable to an increase in orders of aerospace, satellite and weapons
systems electronics products.

Commercial aerospace industry net sales comprised 42.6% of total net sales in
fiscal 1998, up from 34.5% of net sales in fiscal 1997.  Defense industry sales
comprised 19.9% of total net sales in fiscal 1998, down from 21.3% of net sales
in fiscal 1997.

We completed the acquisition of Balo Precision Parts, Inc. ("Balo") in February
1998 and the acquisition of Electronic Specialty Corporation ("ESC"), effective
as of March 1998.  These acquisitions expanded production of hermetically sealed
product offerings and added relay, solenoid and flat panel display product
lines.  See "Description of Business - Products, Processes and Markets - U.S.
Electronics Group." Accordingly, net sales for fiscal 1998 also included
approximately four

                                       47
<PAGE>

months of operations of Balo and three months of operations for ESC,
contributing approximately $4.3 million to net sales in fiscal 1998.

Gross Profit.  Gross profit increased by $6.4 million, or 78.0%, to $14.6
million for fiscal 1998 from $8.2 million in fiscal 1997.  As a percentage of
net sales, gross profit increased to 27.0% in fiscal 1998 from 24.0% in fiscal
1997, which was primarily attributable to increased efficiencies gained in
manufacturing processes and in-house production of processes that had previously
been purchased from outside vendors.  We also believe that capital investments
in equipment and production processes contributed to the improvement in gross
profit margins.

Operating Expenses.   Operating expenses increased by $3.6 million, or 57.1%, to
$9.9 million for fiscal 1998 from $6.3 million in fiscal 1997, partially due to
the Balo and ESC acquisitions and increased levels of operations in fiscal 1998.
As a percentage of net sales, operating expenses remained essentially unchanged.

Adjusted EBITDA.   Adjusted EBITDA increased by $3.6 million, or 109.1%, to $6.9
million for fiscal 1998 from $3.3 million in fiscal 1997.  As a percentage of
net sales, Adjusted EBITDA increased to 12.8% in fiscal 1998 from 9.7% in fiscal
1997.  The increase in Adjusted EBITDA as a percentage of net sales during this
period was primarily attributable to production efficiencies and improved
capacity utilization.

Net Interest Expense.   Net interest expense increased $371,000, or 96.6%, to
$755,000 for fiscal 1998 from $384,000 in fiscal 1997.  This increase was
primarily due to our financing of capital equipment purchases and debt incurred
to finance the expansion of our Wenatchee facilities to support growth in net
sales.

Other Income (Expense).   Other income (expense) represents unusual and non-
operational income and expense for the period.  Other expense increased to
$853,000 expense in fiscal 1998 from income of $169,000 in fiscal 1997.  This
increase of $1,022,000 was due principally to a $1.0 million write-off of
portions of notes receivable and associated debt restructuring and related
expenses in connection with the termination of our efforts during the third
quarter of fiscal 1998 to form an information technology group.

Net Income.   Net income increased by $1.9 million, or 114.9%, to $3.6 million
for fiscal 1998 from $1.7 million in 1997, primarily as a result of the factors
discussed above.

Liquidity and Capital Resources
-------------------------------

Cash and cash equivalents decreased from $8,134,000 as of May 31, 1999, to
$2,154,000 as of May 31, 2000.  Cash used in operating activities was $5.2
million for fiscal 2000, compared to cash used in operating activities of
$372,000 in fiscal 1999.  The increase in our cash used in operating activities
was primarily due to our increased net operating loss, and due to our increase
in inventory levels used to support higher levels of revenue.  Our future
success as a company will depend heavily on our ability to generate cash from
operating activities and to meet our obligations as they become due.  We are
focusing on initiatives to specifically address the need to increase cash
provided by operating activities.  We have reduced staff at some operations to
adjust operations to match current revenue levels.  For example, we have
recently laid off 37 out of 140 employees at our aluminum casting facility in
Entiat, Washington.  Although no product lines are presently for sale, we are
evaluating the profit generated by our products and in the process of shutting
down our casting

                                       48
<PAGE>

operations in Tacoma, Washington and stopping production on unprofitable
products. For example, we are in the process of shutting down our casting
operations in Tacoma, Washington, and stopping production on our ferrous metals
products. These products represent less than 1% of our historical revenue, but
represent approximately 13% of our May 31, 2000 operating loss. We are
attempting to sell excess or slow moving inventories to generate cash and reduce
the overall cost of maintaining higher inventory levels. For example, we have
recently sold to Boeing slow moving inventory used to produce parts for Boeing,
generating approximately $200,000 in cash. We have been focusing on reducing
general and administrative costs by scrutinizing management of professional
service providers, travel expenses, and employee benefits programs. If we are
not sufficiently successful in increasing cash provided by operating activities,
we may need to sell additional equity securities or sell assets outside of the
ordinary course of business in order to meet our obligations. There is no
assurance that we will be able to achieve sufficient cash from operations, sell
additional equity securities, or sell our assets for amounts in excess of book
value. In that situation, our inability to obtain sufficient cash if and when
needed could have a material adverse effect on our financial position, the
results of our operations, and our ability to continue in existence.

Cash used in investing activities decreased from $79.3 million in fiscal 1999 to
$7.7 million in fiscal 2000.  In fiscal 2000 we made cash investments for the
acquisition of equipment ($4.9 million) and investments related to the
acquisition of our U.S. Aerospace Group's Engineering & Fabrication Division
($2.8 million).  We expect to invest an amount in equipment in fiscal 2001 that
is similar to the amount we invested in fiscal 2000.  We currently do not expect
to acquire any new businesses during fiscal 2001.

Cash generated from financing activities decreased from $76.4 million in fiscal
1999 to $6.8 million in fiscal 2000.  Financing activities during fiscal 2000
included net proceeds from the issuance of Common Stock ($4.2 million) and
borrowings under our line of credit ($5.2 million), offset by payments on long-
term debt and capital leases ($2.6 million).  We expect to issue additional
Common Stock during fiscal 2001.  In July 2000, we closed the first installment
of a private placement of Common Stock and warrants, which resulted in gross
proceeds of $2 million.  See "- Significant Events - Equity Financing - Sales of
Common Stock."  We also expect to make additional borrowings under our lines of
credit in order to meet our cash obligations as they become due.  However, we
cannot currently offer assurance that our existing credit facilities will be
renewed and remain available on acceptable terms or at all.

At May 31, 2000, our primary banking relationships included a revolving line of
credit of up to $6.3 million in the U.S., which was scheduled to expire in
September 2000, and a revolving line of credit of up to approximately $5.3
million ((Pounds)3.5 million) in the U.K., which was scheduled to expire in
November 2000. As of May 31, 2000, $5.4 million of the U.S. line was drawn and
the U.K. line was unused. We are currently in preliminary negotiations with our
lenders to renew these credit facilities.  If we are unable to extend our lines
of credit, or if our borrowing limits are decreased, our financial position,
results of operations, and our ability to continue in existence could be
materially and adversely affected.

In December 1998, we entered into an agreement giving us the option to purchase
three parcels of land that make up our Wenatchee campus from the Port of Chelan
County for $5.4 million.  The purchase of the first parcel was completed in
early February 1999.  If we exercise our options to purchase both of the
remaining two parcels, the purchase of the second parcel is expected to close in
December 2000 and the third is expected to close in August 2001.  As of May 31,
2000, we had no other material commitments outstanding for purchases of
additional capital assets.

                                       49
<PAGE>

Our working capital as of May 31, 2000 and 1999 was $29.2 million and $38.3
million, respectively.  The decrease in working capital was primarily due to our
use of cash in operating activities.  We have adopted initiatives directed at
improving cash provided by operating activities during fiscal 2001.  If these
initiatives are successful, positive cash flow coupled with additional cash from
the sale of common stock should increase our working capital during fiscal 2001.

Our current cash balances, credit facilities, and cash from operations may not
be sufficient to meet our operating cash requirements and to fund budgeted
capital expenditures in fiscal 2001. We expect that we will need to obtain
additional cash during fiscal 2001.  Our actual cash needs in fiscal 2001 and
subsequent fiscal years will depend primarily on the amount of cash generated
from or used in operations and on many unpredictable factors, including:
interest due on our variable rate debt; early repayment of debt or other
unexpected cash expenditures; capital expenditures required to remain
competitive; and cash required for acquired companies, future acquisitions, if
any, and financing transaction costs.  As a result of these factors, we cannot
predict accurately the amount or timing of our future cash needs.  If we cannot
obtain sufficient cash if and when needed, we may be unable to fund all our
obligations as they become due or at all.  Should we need to dispose of assets
to generate cash, we can offer no assurance that the carrying values will be
realizable upon liquidation outside of the ordinary course of business.  Our
inability to obtain additional cash if and when needed could have a material
adverse effect on our financial position, results of operations, and our ability
to continue in existence.  Our consolidated financial statements have been
prepared assuming that the Company will continue as a going concern and do not
include any adjustments that might result from the outcome of this uncertainty.

With the acquisition of our European Aerospace Group, whose functional currency
is the British Pound Sterling, we translate the activity of our European
Aerospace Group into U.S. Dollars on a monthly basis.  The balance sheet of the
European Aerospace Group is translated using the exchange rate as of the date of
the balance sheet, and for purposes of the statement of operations and statement
of cash flows we use the weighted  average exchange rate for the period.  The
value of our assets, liabilities, revenue, and expenses may vary materially from
one reporting period to the next solely as a result of varying exchange rates.
During fiscal 1998, 1999 and 2000, the foreign currency translation adjustments
were losses of nil, $1.1 million and $5.1 million, net of tax, respectively.  We
have not entered into any hedging activity as of May 31, 2000.

At May 31, 2000, we had a net operating loss (NOL) carry forward for federal
income tax purposes of approximately $18 million, the benefits of which expire
in the tax year 2002 through the tax year 2020.  The NOL created by our
subsidiaries prior to their acquisition and the NOL created as a consolidated
group or groups subsequent to a qualifying tax free merger or acquisition have
limitations related to the amount of usage by each subsidiary or consolidated
group as described in the Internal Revenue Code.  As a result of these
limitations, approximately $1.5 million of the $18 million NOL will never become
available.  During fiscal 2000, we recorded a valuation allowance of $4.1
million, resulting in a total valuation allowance of $6.3 million at May 31,
2000, because we are uncertain of our ability to realize a portion, or all of
the net deferred tax asset.   Our ability to realize the deferred tax asset is
dependent on material increases in present levels of pre-tax income, primarily
in the U.S.  We expect to achieve these increases through our continued
integration, cross selling, and other operational efficiencies, as well as other
tax strategies.

                                       50
<PAGE>

Significant Events
------------------

Acquisition of Skagit Engineering & Manufacturing, Inc.

On June 1, 1999, we acquired all of the stock of Skagit Engineering &
Manufacturing, Inc. ("Skagit") for $1.3 million in cash. Skagit is a full
service fabricator of high-performance components, assemblies, complete
structures and tooling.  Skagit formed the original basis for the Engineering &
Fabrication Division of our U.S. Aerospace Group.

Acquisition of NOVA-TECH Engineering, Inc.

On May 1, 2000, we completed the acquisition of substantially all the assets and
assumed certain liabilities of NOVA-TECH Engineering, Inc.  ("Nova-Tech") for
$50,000 in cash.  Prior to the acquisition, we advanced $2.5 million to Nova-
Tech.  Nova-Tech specializes in the designing, engineering, and building of
innovative high-productivity equipment for the aerospace industry.  Nova-Tech
was incorporated into the Engineering & Fabrication Division of our U.S.
Aerospace Group.

Exchange of Common Stock for Senior Subordinated Notes

In March, 2000 we exchanged an aggregate of $11.3 million in original principal
amount of our 11 1/4% senior subordinated notes (the "Notes") for a total of
2,902,806 shares of Common Stock in four exchange transactions (the
"Exchanges").  The Exchanges were each conducted with the same noteholder.  The
issuance of the Common Stock to the noteholder in the Exchanges was exempt from
registration under Section 3(a)(9) of the Securities Act.  We believe that the
noteholder resold all of the Common Stock issued in the Exchanges into the
public market prior to April 1, 2000.  The effect of the Exchanges was to reduce
the outstanding principal amount of our Notes from $75 million to $63.7 million,
which substantially reduced the semi-annual interest payment on the Notes from
approximately $4.2 million to $3.6 million.  The exchanges resulted in a
cumulative net of tax extraordinary gain of $703,000.

Equity Financing - Sales of Common Stock

In March 2000, we closed a private offering  of 1,598,000 shares of Common Stock
to 26 accredited investors for net offering proceeds of $4,058,920 (gross
proceeds of $4,794,000, less commissions of $735,080), in a transaction exempt
from registration under Rule 506, promulgated under the Securities Act of 1933,
as amended.  We subsequently filed a registration statement to register the
resale of the shares sold in the offering.

Subsequent to the end of fiscal 2000, in July 2000 we closed a private placement
of Common Stock to two accredited investors.  On that date, we issued 1,142,860
shares of Common Stock and warrants to purchase additional shares of Common
Stock to the investors for a gross amount of $2.0 million.  We filed a
registration statement on Form S-3 with the Securities and Exchange Commission
in August, 2000, to register the resale of shares of Common Stock issued or
issuable as a result of the transaction.  See "PART II - ITEM 5 - MARKET FOR
COMMON EQUITY AND RELATED SHAREHOLDER MATTERS - Summer 2000 Private Placement."

                                       51
<PAGE>

Extension of Expiration Date on Public Warrants

In May 2000, we extended the expiration date on our public warrants from July
15, 2001 to July 15, 2003.  All other terms of the public warrants remained
unchanged.

Orca Technologies, Inc.

In July 1997 we guaranteed a $1.3 million line of credit between Orca
Technologies, Inc. and its principal lender.  This guarantee was made in
connection with our 1997 plan to form an information technology group.  We
terminated that effort in late 1997.  In June 1999, as guarantor of Orca's line
of credit, we advanced $300,000 for a partial repayment of the line of credit
required by the lender.  In October 1999, we advanced an additional $522,000 for
another partial repayment required by the lender.  During the second quarter of
fiscal 2000, we advanced $509,000, and early in the third quarter of fiscal 2000
we advanced $82,000, which completely repaid the guaranteed debt.  During fiscal
1999, we recorded in other expense an allowance for certain expenses and the
guarantee of Orca's line of credit totaling approximately $2.0 million.  This
allowance had the effect of writing off the entire amount of our guarantee
obligation prior to fiscal 2000.  As a result, the payments described above
affected cash flow, but did not affect earnings during fiscal 2000.  We also
reserved the entire amount of an unpaid promissory note in the principal amount
of $950,000 in other expense during fiscal 1998 and fiscal 1999.  We do not
believe that Orca is currently operating as a going concern.  In September 2000,
at Orca's request, and in order to facilitate a proposed sale by Orca of its
assets, we signed a non-binding letter of intent to transfer the previously
written-off notes and stock to a group led by Orca's chief executive officer, in
exchange for a $20,000 note payable to us.  We do not currently know whether
that transaction will go forward.  When we made the guarantee in July, 1997,
some of our directors and executive officers had interests in Orca as directors,
shareholders, or guarantors of Orca debt.  Donald A. Wright, a director and an
executive officer of Pacific Aerospace, and Nick A. Gerde, an executive officer
of Pacific Aerospace, were directors of Orca until June 1997 and shareholders of
Orca until May 1998.  Roger Vallo, who was a director of Pacific Aerospace until
January 1998, is the chief executive officer and a director of Orca.  Donald
Cotton, a former director of Pacific Aerospace who served until January 1998,
was, and may still be, a director of Orca.  Mr. Vallo and Mr. Cotton resigned
from the Pacific Aerospace Board of Directors shortly after Pacific Aerospace
decided not to pursue the information technology group.  Dr. Allen Dahl, a
director of Pacific Aerospace until October 10, 2000, previously was a
shareholder of Orca.  Messrs. Wright, Gerde, Vallo and Cotton had also
personally guaranteed a portion of Orca's bank debt.   Since February, 1998,
none of our directors or executive officers have been directors of Orca.  Our
transactions with Orca were approved at various times by the disinterested
members of our board of directors.  None of our directors or executive officers
currently have any interests in Orca.

New Accounting Pronouncements

In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 101, as amended, Revenue Recognition in Financial
Statements.  SAB No. 101 provides guidance for revenue recognition and the SEC
staff's views on the application of accounting principles to selected revenue
recognition issues.  We will adopt the provisions of SAB No. 101 in the first
quarter of fiscal year 2001.  We have not determined the impact the adoption of
SAB No. 101 will have on our consolidated financial statements.

In March 2000, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation.  Interpretation No. 44 clarifies the

                                       52
<PAGE>

application of APB Opinion No. 25 and is effective July 1, 2000. Interpretation
No. 44 clarifies the definition of "employee" for purposes of applying APB
Opinion No. 25, the criteria for determining whether a plan qualifies as a
noncompensatory plan, the accounting consequence of various modifications to the
terms of a previously fixed stock option or award, and the accounting for an
exchange of stock compensation awards in a business combination. We will adopt
the provisions of FASB Interpretation No. 44 in the first quarter of fiscal year
2001. We have not determined the impact the adoption of Interpretation No. 44
will have on our consolidated financial statements.

In June 1998, the FASB issued SFAS No. 133, as amended, Accounting for
Derivative Instruments and Hedging Activities. SFAS No. 133 requires the
recognition of all derivatives in the consolidated balance sheet as either
assets or liabilities measured at fair value. We will adopt the provision of
SFAS No. 133 in the first quarter of fiscal year 2002. We have not determined
the impact the adoption of SFAS No. 133 will have on our consolidated financial
statements.

ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have financial instruments that are subject to interest rate risk, primarily
debt obligations issued at a fixed rate. However, fixed-rate debt obligations
issued by us are generally not callable until maturity. The fair value of such
instruments approximates their face value except for the Notes which, as of May
31, 2000, were trading on the open market for approximately 60% of face value.
We do not consider the market risk exposure for interest rates to be material.

We are subject to foreign currency exchange rate risk relating to receipts from
and payments to suppliers in foreign currencies. Since approximately 50% of the
Company transactions are conducted in foreign currency, the exchange rate risk
could be material. During fiscal 1998, 1999 and 2000, the foreign currency
translation adjustments were losses of nil, $1.1 million and $5.1 million, net
of tax, respectively. We have not entered into any hedging activity as of May
31, 2000.

We are exposed to commodity price fluctuations through purchases of aluminum,
titanium, and other raw materials. We enter into certain supplier agreements
that guarantee quantity and price of the applicable commodity to limit the
exposure to commodity price fluctuations and availability concerns. At May 31,
2000, we had purchase commitments for raw materials aggregating $4,240,000.
These commitments assure us a future fixed cost for some materials, establish
delivery criteria, minimum monthly quantities, and material specifications. Of
the Company's $4,240,000 purchase commitments for raw materials at May 31, 2000,
$1,600,000 related to an aluminum supply purchase order with a fixed price that
goes through October 2001, and the remainder related to a titanium supply
agreement with a fixed price that goes through December 2001. These commitments
at May 31, 2000 represented less than 5% of the Company's cost of goods sold for
fiscal 2000.

                                      53
<PAGE>

ITEM 8.  FINANCIAL STATEMENTS

INDEPENDENT AUDITORS' REPORT


The Board of Directors
Pacific Aerospace & Electronics, Inc.:

We have audited the accompanying consolidated balance sheets of Pacific
Aerospace & Electronics, Inc. and subsidiaries as of May 31, 1999 and 2000, 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, 2000.
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 auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits 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 Pacific Aerospace &
Electronics, Inc. and subsidiaries as of May 31, 1999 and 2000, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the each of the years in the three-year period ended May 31, 2000 in conformity
with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 3 to the
consolidated financial statements, the Company has suffered recurring losses
from operations, which raise substantial doubt about its ability to continue as
a going concern. Management's plans in regard to these matters are also
described in Note 3. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.

/s/ KPMG LLP

Seattle, Washington
July 28, 2000

                                      54
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                          Consolidated Balance Sheets

                             May 31, 1999 and 2000

<TABLE>
<CAPTION>

                                   Assets                                              1999              2000
                                                                                   -------------    -------------
<S>                                                                                <C>              <C>
Current assets:
    Cash and cash equivalents                                                      $   8,134,000        2,154,000
    Accounts receivable, net of allowance for doubtful accounts of
      $355,000 in 1999 and $495,000 in 2000.                                          24,992,000       21,210,000
    Inventories                                                                       24,616,000       27,849,000
    Deferred income taxes                                                                880,000          872,000
    Prepaid expenses and other                                                         2,316,000        1,668,000
                                                                                   -------------    -------------
                Total current assets                                                  60,938,000       53,753,000
                                                                                   -------------    -------------
Property, plant and equipment, net                                                    45,279,000       44,076,000
                                                                                   -------------    -------------
Other assets:
    Notes receivable from related parties                                              1,458,000               --
    Costs in excess of net book value of acquired subsidiaries, net of
      accumulated amortization of $1,430,000 in 1999 and $2,659,000 in 2000.          41,052,000       38,291,000
    Patents, net of accumulated amortization of $407,000 in 1999
      and $509,000 in 2000.                                                            1,255,000        1,158,000
    Deferred financing costs, net of accumulated amortization of
      $664,000 in 1999 and $1,433,000 in 2000.                                         5,029,000        3,597,000
    Deferred income taxes                                                              3,395,000        2,303,000
    Other                                                                                321,000          404,000
                                                                                   -------------    -------------
                Total other assets                                                    52,510,000       45,753,000
                                                                                   -------------    -------------
                                                                                   $ 158,727,000      143,582,000
                                                                                   =============    =============


                      Liabilities and Stockholders' Equity

Current liabilities:
    Accounts payable                                                               $  10,484,000       10,630,000
    Accrued liabilities                                                                5,615,000        4,589,000
    Accrued interest                                                                   2,813,000        2,372,000
    Current portion of long-term debt                                                  1,278,000        1,098,000
    Current portion of capital lease obligations                                         297,000          504,000
    Line of credit                                                                            --        5,379,000
    Other current liabilities                                                          2,122,000               --
                                                                                   -------------    -------------
                Total current liabilities                                             22,609,000       24,572,000

Long-term liabilities:
    Long-term debt, net of current portion                                             5,220,000        4,161,000
    Capital lease obligations, net of current portion                                  1,615,000        1,065,000
    Senior subordinated notes payable                                                 75,000,000       63,700,000
    Deferred rent and other                                                              264,000          316,000
                                                                                   -------------    -------------
                Total liabilities                                                    104,708,000       93,814,000
                                                                                   -------------    -------------
Stockholders' equity (deficit):
    Series B convertible  preferred  stock, $0.001 par value, 5,000,000 shares
      authorized, 161,035 and 34,529 shares issued and outstanding at May 31,
      1999 and 2000, respectively.                                                            --               --
    Common stock, $0.001 par value, 100,000,000 shares authorized,
      18,932,779 and 30,283,621 shares issued and outstanding at
      May 31, 1999 and 2000, respectively.                                                19,000           30,000
    Additional paid-in capital                                                        69,276,000       83,173,000
    Accumulated other comprehensive loss                                              (1,140,000)      (6,250,000)
    Accumulated deficit                                                              (14,136,000)     (27,185,000)
                                                                                   -------------    -------------
                Total stockholders' equity                                            54,019,000       49,768,000

Commitments, contingencies and subsequent event                                               --               --
                                                                                   -------------    -------------
                                                                                   $ 158,727,000      143,582,000
                                                                                   =============    =============
</TABLE>

See accompanying notes to consolidated financial statements.

                                      55
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                     Consolidated Statements of Operations

                    Years ended May 31, 1998, 1999 and 2000

<TABLE>
<CAPTION>
                                                                      1998            1999            2000
                                                                  ------------    ------------    ------------
<S>                                                               <C>             <C>             <C>
Net sales                                                         $ 54,099,000     107,366,000     112,694,000
Cost of sales                                                       39,487,000      86,302,000      92,063,000
                                                                  ------------    ------------    ------------
                   Gross profit                                     14,612,000      21,064,000      20,631,000

Operating expenses                                                   9,872,000      22,039,000      24,533,000
                                                                  ------------    ------------    ------------
                   Income (loss) from operations                     4,740,000        (975,000)     (3,902,000)
                                                                  ------------    ------------    ------------

Other income (expense):
    Interest income                                                    110,000         532,000          97,000
    Interest expense                                                  (865,000)     (8,672,000)     (9,959,000)
    Other                                                             (853,000)     (6,393,000)         33,000
                                                                  ------------    ------------    ------------
                   Total other expense                              (1,608,000)    (14,533,000)     (9,829,000)
                                                                  ------------    ------------    ------------

                   Income (loss) before income tax
                       benefit (expense) and extraordinary item      3,132,000     (15,508,000)    (13,731,000)

Income tax benefit (expense)                                           482,000       2,639,000         (21,000)
                                                                  ------------    ------------    ------------
                   Net income (loss) before extraordinary item       3,614,000     (12,869,000)    (13,752,000)

Extraordinary item, net of tax of $362,000                                  --              --         703,000
                                                                  ------------    ------------    ------------
                   Net income (loss)                                 3,614,000     (12,869,000)    (13,049,000)

Other comprehensive income (loss):
    Foreign currency translation                                            --      (1,727,000)     (4,523,000)
    Income tax benefit (expense)                                            --         587,000        (587,000)
    Valuation of available for sale securities                        (436,000)        436,000              --
                                                                  ------------    ------------    ------------
                   Total other comprehensive loss                     (436,000)       (704,000)     (5,110,000)
                                                                  ------------    ------------    ------------
                   Comprehensive income (loss)                    $  3,178,000     (13,573,000)    (18,159,000)
                                                                  ============    ============    ============

Net income (loss) per share:
    Basic                                                         $       0.29           (0.74)          (0.59)
    Diluted                                                               0.27           (0.74)          (0.59)

Shares used in computation of net income (loss) per share:
       Basic                                                        12,486,077      17,359,491      21,955,473
       Diluted                                                      13,606,061      17,359,491      21,955,473
</TABLE>

See accompanying notes to consolidated financial statements.

                                       56
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                Consolidated Statements of Stockholders' Equity

                    Years ended May 31, 1998, 1999 and 2000

<TABLE>
<CAPTION>
                                                                   Series A                  Series B
                                                                 convertible               convertible
                                                               preferred stock           preferred stock         Common stock
                                                           -----------------------   ----------------------  --------------------
                                                             Shares        Amount      Shares       Amount     Shares     Amount
                                                           -----------    --------   ---------     --------  ---------- ----------
<S>                                                        <C>            <C>        <C>           <C>       <C>         <C>
Balance at May 31, 1997                                        50,000     $    --          --      $     --  10,220,249   $ 10,000

Issuance of common stock                                           --          --          --            --       8,559         --
Sale of common stock for cash                                      --          --          --            --     524,000      1,000
Issuance of preferred stock, net of issuance cost $740,000         --          --     100,000            --          --         --
Issuance of warrants                                               --          --          --            --          --         --
Exercise of warrants for cash, net of tax effect of $99,000        --          --          --            --     795,000      1,000
Issuance of common stock on conversion of
  convertible notes and accrued interest of $154,000               --          --          --            --   1,405,018      1,000
Exercise of options for cash                                       --          --          --            --      25,000         --
Issuance of common stock on conversion of preferred stock     (50,000)         --          --            --   1,494,593      1,000
Unrealized loss on available for sale securities                   --          --          --            --          --         --
Issuance of common stock in connection with acquisition            --          --          --            --     923,304      1,000
Net income                                                         --          --          --            --          --         --
                                                              -------     -------    --------      --------  ----------   --------
Balance at May 31, 1998                                            --          --     100,000            --  15,395,723     15,000

Issuance of preferred stock, net of issuance costs of
  $370,000                                                         --          --      70,000            --          --         --
Issuance of common stock for services                              --          --          --            --     590,000      1,000
Cancellation of warrants                                           --          --          --            --          --         --
Valuation of available for sale securities                         --          --          --            --          --         --
Foreign currency translation adjustment, net of tax effect
  of $587,000                                                      --          --          --            --          --         --
Issuance of common stock on conversion of Series B
  preferred stock                                                  --          --      (8,965)           --     545,114         --
Issuance of common stock under employee stock
  purchase plan, net of related expenses of $4,000                 --          --          --            --      41,942         --
Sale of common stock for cash, net of issuance
  costs of $344,000                                                --          --          --            --   2,585,000      3,000
Common shares redeemed in connection with a prior
  acquisition                                                      --          --          --            --    (225,000)        --
Net loss                                                           --          --          --            --          --         --
                                                              -------     -------    --------      --------  ----------   --------
Balance at May 31, 1999                                            --          --     161,035            --  18,932,779     19,000

Issuance of common stock under employee stock
  purchase plan, net of related expenses of $12,000                --          --          --            --     142,696         --
Sale of common stock for cash, net of issuance
  costs of $788,000                                                --          --          --            --   1,598,000      1,000
Issuance of warrants                                               --          --          --            --          --         --
Exercise of warrants for cash, net                                 --          --          --            --      25,000         --
Issuance of common stock in exchange for senior
  subordinated notes                                               --          --          --            --   2,902,806      3,000
Issuance of common stock on conversion of Series B
  preferred stock, net of issuance costs of $60,000                --          --    (126,506)           --   6,682,340      7,000
Foreign currency translation adjustment, net of
  tax effect of $587,000                                           --          --          --            --          --         --
Net loss                                                           --          --          --            --          --         --
                                                              -------     -------    --------      --------  ----------   --------
Balance at May 31, 2000                                            --     $    --      34,529      $     --  30,283,621   $ 30,000
                                                              =======     =======    ========      ========  ==========   ========

<CAPTION>
                                                                            Accumulated
                                                              Additional       other                       Total
                                                                paid-in    comprehensive  Accumulated   stockholders'
                                                                capital        loss         deficit        equity
                                                              -----------  -------------  -----------   -------------
<S>                                                           <C>          <C>            <C>            <C>
Balance at May 31, 1997                                       30,490,000          --      (4,881,000)    25,619,000

Issuance of common stock                                          13,000          --              --         13,000
Sale of common stock for cash                                  2,222,000          --              --      2,223,000
Issuance of preferred stock, net of issuance cost $740,000     9,260,000          --              --      9,260,000
Issuance of warrants                                             444,000          --              --        444,000
Exercise of warrants for cash, net of tax effect of $99,00     3,723,000          --              --      3,724,000
Issuance of common stock on conversion of
  convertible notes and accrued interest of $154,000           5,518,000          --              --      5,519,000
Exercise of options for cash                                      53,000          --              --         53,000
Issuance of common stock on conversion of preferred stock         (1,000)         --              --             --
Unrealized loss on available for sale securities                      --    (436,000)             --       (436,000)
Issuance of common stock in connection with acquisition        6,108,000          --              --      6,109,000
Net income                                                            --          --       3,614,000      3,614,000
                                                             -----------  ----------     -----------    -----------
Balance at May 31, 1998                                       57,830,000    (436,000)     (1,267,000)    56,142,000

Issuance of preferred stock, net of issuance costs of
  $370,000                                                     6,630,000          --              --      6,630,000
Issuance of common stock for services                          1,769,000          --              --      1,770,000
Cancellation of warrants                                        (360,000)         --              --       (360,000)
Valuation of available for sale securities                            --     436,000              --        436,000
Foreign currency translation adjustment, net of tax effect
  of $587,000                                                         --  (1,140,000)             --     (1,140,000)
Issuance of common stock on conversion of Series B
  preferred stock                                                     --          --              --             --
Issuance of common stock under employee stock
  purchase plan, net of related expenses of $4,000                72,000          --              --         72,000
Sale of common stock for cash, net of issuance
  costs of $344,000                                            4,823,000          --              --      4,826,000
Common shares redeemed in connection with a prior
  acquisition                                                 (1,488,000)         --              --     (1,488,000)
Net loss                                                              --          --     (12,869,000)   (12,869,000)
                                                             -----------  ----------     -----------    -----------
Balance at May 31, 1999                                       69,276,000  (1,140,000)    (14,136,000)    54,019,000

Issuance of common stock under employee stock
  purchase plan, net of related expenses of $12,000              163,000          --              --        163,000
Sale of common stock for cash, net of issuance
  costs of $788,000                                            4,005,000          --              --      4,006,000
Issuance of warrants                                              60,000          --              --         60,000
Exercise of warrants for cash, net                                86,000          --              --         86,000
Issuance of common stock in exchange for senior
  subordinated notes                                           9,650,000          --              --      9,653,000
Issuance of common stock on conversion of Series B
  preferred stock, net of issuance costs of $60,000              (67,000)         --              --        (60,000)
Foreign currency translation adjustment, net of
  tax effect of $587,000                                              --  (5,110,000)             --     (5,110,000)
Net loss                                                              --          --     (13,049,000)   (13,049,000)
                                                             -----------  ----------     -----------    -----------
Balance at May 31, 2000                                       83,173,000  (6,250,000)    (27,185,000)    49,768,000
                                                              ==========  ==========     ===========    ===========
</TABLE>

See accompanying notes to consolidated financial statements.

                                       57
<PAGE>

                                   PACIFIC AEROSPACE & ELECTRONICS, INC.
                                             AND SUBSIDIARIES

                                   Consolidated Statements of Cash Flows

                                  Years ended May 31, 1998, 1999 and 2000

<TABLE>
<CAPTION>
                                                                             1998            1999             2000
                                                                          ------------    ------------    ------------
<S>                                                                       <C>             <C>             <C>
Cash flow from operating activities:
    Net income (loss)                                                     $  3,614,000     (12,869,000)    (13,049,000)
    Adjustments to reconcile net income (loss) to net
      cash provided by (used in) operating activities:
        Depreciation and amortization                                        2,204,000       6,705,000       7,741,000
        Allowance on note receivable and guarantees                            250,000       2,884,000              --
        Loss on restructuring of note receivable                             1,038,000              --              --
        Impairment of certain long lived assets                                     --       3,275,000       5,304,000
        Unrealized loss on investment                                               --       4,943,000          19,000
        Gain on early extinguishment of debt                                        --              --        (703,000)
        Other nonoperating expenses                                            152,000         750,000          (8,000)
        Income tax benefit (expense)                                        (1,200,000)     (4,287,000)        151,000
        Changes in operating assets and liabilities:
           Accounts receivable                                              (2,286,000)       (121,000)      3,250,000
           Inventories                                                      (3,387,000)      2,751,000      (3,072,000)
           Prepaid expenses and other current assets                           474,000        (421,000)       (137,000)
           Other assets                                                     (1,176,000)      1,077,000      (2,307,000)
           Accounts payable, accrued liabilities and other liabilities       1,911,000      (5,059,000)     (2,396,000)
                                                                          ------------    ------------    ------------
               Net cash provided by (used in) operating activities           1,594,000        (372,000)     (5,207,000)
                                                                          ------------    ------------    ------------
Cash flow from investing activities:
    Acquisition of property, plant and equipment                            (6,509,000)     (8,040,000)     (4,867,000)
    Acquisition of subsidiaries                                             (4,318,000)    (69,752,000)     (1,350,000)
    Issuance of notes receivable                                            (6,261,000)     (1,458,000)     (1,505,000)
    Other changes, net                                                         383,000         (24,000)         49,000
                                                                          ------------    ------------    ------------
               Net cash used in investing activities                       (16,705,000)    (79,274,000)     (7,673,000)
                                                                          ------------    ------------    ------------
Cash flow from financing activities:
    Net borrowings (repayments) under line of credit                          (358,000)     (1,511,000)      5,218,000
    Proceeds from long-term debt                                            10,125,000      72,160,000              --
    Payments on long-term debt and capital leases                           (1,503,000)     (5,752,000)     (2,603,000)
    Proceeds from sale of common stock, net                                  2,223,000       4,898,000       4,169,000
    Proceeds from sale of preferred stock, net                               9,260,000       6,630,000         (60,000)
    Proceeds from exercise of warrants                                       3,724,000              --          86,000
    Other changes, net                                                          53,000              --          24,000
                                                                          ------------    ------------    ------------
             Net cash provided by financing activities                      23,524,000      76,425,000       6,834,000
                                                                          ------------    ------------    ------------
             Net increase (decrease) in cash and cash equivalents            8,413,000      (3,221,000)     (6,046,000)

Effect of exchange rates on cash                                                    --        (106,000)         66,000

Cash and cash equivalents at beginning of year                               3,048,000      11,461,000       8,134,000
                                                                          ------------    ------------    ------------

Cash and cash equivalents at end of year                                  $ 11,461,000       8,134,000       2,154,000
                                                                          ============    ============    ============

Supplemental cash flow:
    Cash paid during the year for:
      Interest                                                            $    712,000       5,296,000       9,563,000
      Income taxes                                                             521,000         411,000       2,232,000
Acquisition of subsidiaries:
    Fair value of assets acquired and resulting goodwill, excluding cash    10,034,000      86,593,000       9,801,000
    Liabilities assumed                                                      3,925,000      16,811,000       5,814,000
    Common stock issued                                                      6,109,000              --              --
Noncash investing and financing activities:
    Seller financed acquisition of property, plant and equipment             3,336,000         241,000              --
    Conversion of notes and accrued interest to common stock                 5,519,000              --      11,457,000
    Restructuring of certain notes receivable for an investment in
      common stock                                                           6,053,000              --              --
    Other noncash investing and financing activities                           889,000              --              --
    Reclassification of property, plant and equipment to other assets               --       1,217,000              --
</TABLE>

See accompanying notes to consolidated financial statements.

                                       58
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000

(1)  Description of Business and Basis of Presentation

     (a)  Description of Business

          Pacific Aerospace & Electronics, Inc., headquartered in Wenatchee,
          Washington, is an international engineering and manufacturing company
          which develops, manufactures and markets high performance electronic
          and metal components and assemblies for the aerospace, defense,
          electronics, medical, energy, telecommunications, and transportation
          industries. The consolidated financial statements include the accounts
          of Pacific Aerospace & Electronics, Inc. and its wholly-owned
          subsidiaries (collectively, the "Company").

     (b)  Basis of Presentation

          These consolidated financial statements are prepared in accordance
          with generally accepted accounting principles (GAAP) in the United
          States of America (U.S.) and present the financial position, results
          of operations and changes in financial position of the Company. All
          material intercompany balances and transactions have been eliminated
          in consolidation.

          Certain 1998 and 1999 amounts have been reclassified to conform with
          the 2000 presentation.

(2)  Summary of Significant Accounting Principles

     (a)  Cash and Cash Equivalents

          Cash and cash equivalents consist of cash, demand deposits with banks
          and highly liquid investments with maturity dates at purchase of three
          months or less.

     (b)  Inventories

          Inventories are stated at the lower of cost, primarily determined by
          the first-in, first-out method, or market (replacement cost for raw
          materials and net realizable value for work in progress and finished
          goods).

     (c)  Property, Plant and Equipment

          Property, plant and equipment are stated at cost. Property, plant and
          equipment under capital leases are stated at the lower of the fair
          market value of the assets or the present value of minimum lease
          payments at the inception of the leases.

          Depreciation and amortization are calculated using the straight-line
          method over the estimated useful lives of the owned assets ranging
          from 5 years for certain machinery and equipment to 40 years for
          certain buildings. Property, plant and equipment held under capital
          leases are amortized using the straight-line method over the shorter
          of the estimated useful lives of the assets or the lease terms,
          ranging from 7 to 10 years.

                                       59                            (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


          Expenditures for maintenance and repairs are charged to expense as
          incurred. Upon sale or retirement, the cost and related accumulated
          depreciation or amortization are removed from the accounts and any
          resulting gain or loss is reflected in other income or expense.

     (d)  Intangible Assets

          Costs in excess of net book value of acquired subsidiaries are
          amortized using the straight-line method over a period ranging from 10
          to 40 years from the date of acquisition.

          Patents are amortized using the straight-line method over the
          estimated useful lives of the patents ranging from 10 to 17 years.

          Deferred financing costs were incurred in connection with the Senior
          Subordinated Note offering and are being amortized using the straight-
          line method over the seven-year life of the notes.

     (e)  Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed
          Of

          Long-lived assets and certain identifiable intangibles are reviewed
          for impairment whenever events or changes in circumstances indicate
          that the carrying amount of an asset may not be recoverable.
          Recoverability of assets to be held and used is measured by a
          comparison of the carrying amount of an asset to future net cash flows
          expected to be generated by the asset. If such assets are considered
          to be impaired, the impairment to be recognized is measured by the
          amount by which the carrying amount of the assets exceed the fair
          value of the assets. Assets to be disposed of are reported at the
          lower of the carrying amount or fair value less costs to sell.

     (f)  Revenue Recognition

          Revenue is primarily recognized when products are shipped to customers
          and when services are performed.

     (g)  Research and Development

          Research and development costs are expensed as incurred and are
          included in cost of sales.

     (h)  Income Taxes

          The Company follows the asset and liability method of accounting for
          income taxes. Under the asset and liability method of accounting for
          income taxes, deferred tax assets and liabilities are recognized based
          on the estimated future tax consequences attributable to differences
          between the consolidated financial statement carrying amounts of
          existing assets and liabilities and their respective tax bases.
          Deferred tax assets and liabilities are measured using enacted tax
          rates in effect for the year in which those temporary differences are
          expected to be recovered or settled. The effect on deferred tax assets
          and liabilities of a change in tax rates is recognized in the period
          that includes the enactment date.

                                       60                            (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


     (i)  Stock-Based Compensation

          The Company follows the provisions of Statement of Financial
          Accounting Standards (SFAS) No. 123, Accounting for Stock-Based
          Compensation. This statement permits a company to choose either a new
          fair-value method or the Accounting Principles Board (APB) Opinion No.
          25, Accounting for Stock Issued to Employees, intrinsic-value based
          method of accounting for stock-based compensation arrangements. SFAS
          No. 123 requires pro forma disclosure of net income (loss) and
          earnings (loss) per share computed as if the fair-value based method
          had been applied in financial statements of companies that continue to
          account for such arrangements under APB Opinion No. 25. The Company
          has elected to continue to record stock-based compensation using the
          APB Opinion No. 25 intrinsic-value-based method and, therefore, the
          adoption of SFAS No. 123 has not significantly impacted the Company's
          financial positions, results of operations, or liquidity.

     (j)  Net Income (Loss) Per Share

          Basic income (loss) per share is computed using the weighted average
          number of common shares outstanding during the period. Diluted income
          (loss) per share is computed using the weighted average number of
          common and dilutive common equivalent shares outstanding during the
          period using the treasury stock method. As the Company had a net loss
          for the years ended May 31, 1999 and 2000, basic and diluted net loss
          per share are the same.

     (k)  Foreign Currency

          The functional currency of the Company's foreign subsidiaries is the
          local currency of the country in which the subsidiary is incorporated.
          Assets and liabilities of foreign operations are translated into U.S.
          dollars using rates of exchange in effect at the end of the reporting
          period. Income and expense accounts are translated into U.S. dollars
          using average rates of exchange during the reporting period. The net
          gain or loss resulting from translation is shown as a foreign currency
          translation adjustment and is included in accumulated other
          comprehensive income (loss) in stockholders' equity. Gains and losses
          from foreign currency transactions are included in other income or
          expense in the consolidated statements of operations. There were no
          significant foreign currency transaction gains or losses for the years
          ended May 31, 1998, 1999 and 2000.

     (l)  Comprehensive Income (Loss)

          The Company follows the provisions of SFAS No. 130, Reporting
          Comprehensive Income, which establishes standards for the reporting
          and disclosure of comprehensive income and its components (revenues,
          expenses, gains and losses) in a full set of consolidated financial
          statements. The Company's other comprehensive income (loss) primarily
          consists of the valuation of available-for-sale securities and foreign
          currency translation adjustments.

                                       61                            (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


     (m)  Use of Estimates

          The preparation of consolidated financial statements in conformity
          with GAAP requires management to make estimates and assumptions that
          affect the reported amounts of assets and liabilities and disclosure
          of contingent assets and liabilities at the date of the consolidated
          financial statements and the reported amounts of revenues and expenses
          during the reporting period. Actual results could differ from those
          estimates.

     (n)  New Accounting Pronouncements

          In December 1999, the Securities and Exchange Commission (SEC) issued
          Staff Accounting Bulletin (SAB) No. 101, as amended, Revenue
          Recognition in Financial Statements. SAB No. 101 provides guidance for
          revenue recognition and the SEC staff's views on the application of
          accounting principles to selected revenue recognition issues. We will
          adopt the provisions of SAB No. 101 in the fourth quarter of fiscal
          year 2001. We have not determined the impact the adoption of SAB No.
          101 will have on our consolidated financial statements.

          In March 2000, the Financial Accounting Standards Board (FASB) issued
          Interpretation No. 44, Accounting for Certain Transactions Involving
          Stock Compensation. Interpretation No. 44 clarifies the application of
          APB Opinion No. 25 and is effective July 1, 2000. Interpretation No.
          44 clarifies the definition of "employee" for purposes of applying APB
          Opinion No. 25, the criteria for determining whether a plan qualifies
          as a noncompensatory plan, the accounting consequence of various
          modifications to the terms of a previously fixed stock option or
          award, and the accounting for an exchange of stock compensation awards
          in a business combination. We will adopt the provisions of FASB
          Interpretation No. 44 in the first quarter of fiscal year 2001. We
          have not determined the impact the adoption of Interpretation No. 44
          will have on our consolidated financial statements.

          In June 1998, the FASB issued SFAS No. 133, as amended, Accounting for
          Derivative Instruments and Hedging Activities. SFAS No. 133 requires
          the recognition of all derivatives in the consolidated balance sheet
          as either assets or liabilities measured at fair value. We will adopt
          the provision of SFAS No. 133 in the first quarter of fiscal year
          2002. We have not determined the impact the adoption of SFAS No. 133
          will have on our consolidated financial statements.

                                       62                            (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


(3)  Going Concern

     The Company's consolidated financial statements have been prepared assuming
     the Company will continue as a going concern.

     Cash and cash equivalents decreased from $8,134,000 as of May 31, 1999 to
     $2,154,000 as of May 31, 2000. Cash used in operating activities was
     $5,207,000 for fiscal year 2000 compared to cash used in operating
     activities of $372,000 in fiscal year 1999. The Company's future success
     will depend heavily on its ability to generate cash from operating
     activities and to meet its obligations as they become due. The Company is
     focusing on initiatives that specifically address the need to increase cash
     provided by operating activities. Some of these initiatives include, but
     are not limited to possible staff reductions, reduced product line
     offerings, selling of excess inventory, and general and administrative cost
     controls. If the Company is not sufficiently successful in increasing cash
     provided by operating activities, it may need to sell additional common
     stock or sell assets outside of the ordinary course of business in order to
     meet its obligations. There is no assurance that the Company will be able
     to achieve sufficient cash from operations, to sell additional common
     stock, or to sell our assets for amounts in excess of book value. See notes
     9 and 23 for additional disclosures about the Company's potential future
     sources of cash.

     The Company believes that its current cash balances, credit facilities,
     proceeds from the summer 2000 equity placement, and cash from operations
     may be sufficient to meet its operating cash requirements and to fund
     budgeted capital expenditures in fiscal year 2001. However, the Company may
     determine that it needs to obtain additional cash during fiscal year 2001.
     The Company's actual cash needs will depend on many unpredictable factors,
     including: cash generated from or used by operations, interest due on
     variable rate debt, early repayment of debt or other unexpected cash
     expenditures, capital expenditures required to remain competitive, cash
     required for acquired companies, future acquisitions, if any, and financing
     transaction costs. As a result of these factors, the Company cannot predict
     accurately the amount or timing of future cash needs. If the Company cannot
     obtain sufficient cash if and when needed, the Company may be unable to
     fund all obligations as they become due or at all. Should the Company need
     to dispose of assets to generate cash, the Company can offer no assurance
     that the carrying values will be realizable upon liquidation outside the
     ordinary course of business. The Company's ability to obtain additional
     cash if and when needed could have a material adverse effect on its
     financial position, results of operations and its ability to continue in
     existence. The consolidated financial statements do not include any
     adjustments that might result from the outcome of this uncertainty.

(4)  Impairment of Long-Lived Assets

     Included in operating expenses in the years ended May 31, 1999 and 2000 are
     $4.9 million and $5.2 million in non-cash charges related to the impairment
     of long-lived assets. The Company reviews long-lived assets and intangibles
     for potential impairment of value whenever events or changes in
     circumstances indicate that the carrying amount of those assets may not be
     recoverable. The fair value of those assets is determined using the present
     value of the estimated future cash flows derived from those assets. During
     the year ended May 31, 1999 the Company determined that due to continued
     losses related to the Electronic Group's Displays Division that impairment
     of approximately $4.7 million existed in that division. The impairment was
     comprised of goodwill, $3.6 million, and personal property, $1.1 million.
     The carrying amount of goodwill was $3.6 million prior to the impairment
     charge and $0 after the impairment charge. The carrying amount of personal
     property, which consisted of manufacturing equipment, computer hardware,
     and office furniture, was $3.5 million before the impairment charge and
     $2.4 million after the impairment charge. Also, during the year ended May
     31, 1999 the Company recognized an impairment charge of $0.2 million to
     reduce the carrying value, $1.6 million, of manufacturing equipment used in
     the Electronic Group's Interconnect Division to its estimated fair value,
     $1.4 million. During the year ended May 31, 2000 due to continuing losses,
     weaknesses in the commercial aerospace and transportation industries and
     cancellation and postponement of projects by major customers in our
     Engineering & Fabrication Division, the Company's evaluation resulted in
     the realization of a $4.6 million impairment of goodwill and a $600,000
     property impairment related to the Company's U.S. Aerospace Group. The
     carrying amount of the goodwill was $6.6 million prior to the impairment
     charge and $2.0 million after the impairment charge. The carrying amount of
     the personal property, which consisted of manufacturing equipment, was
     $600,000 prior to the impairment charge and $0 after the impairment charge.
     The Company will continue to evaluate the assets, especially in the U.S.
     Aerospace Group, on a quarterly basis, until such time as the Company
     becomes consistently profitable. Future evaluations could result in
     additional impairment charges, primarily for goodwill and property, plant
     and equipment.

                                      63                             (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


(5)  Segment Information and Concentration of Risk

The Company is organized into three operational segments, "U.S. Aerospace, "
"European Aerospace," and "U.S. Electronics." The Aerospace segments are
primarily comprised of machined, formed and cast metal product operations. Net
sales of the Aerospace segments include sales to customers in the aerospace,
defense and transportation industries. Net sales of the Electronics segment also
include sales to customers in the aerospace and defense industries.
Historically, these segments have been cyclical and sensitive to general
economic and industry specific conditions. In particular, the aerospace
industry, in recent years, has been adversely affected by a number of factors,
including reduced demand for commercial aircraft, a decline in military
spending, postponement of overhaul and maintenance of aircraft, increased fuel
and labor costs, increased regulations, and intense price competition, among
other factors. In addition, there is no assurance that general economic
conditions will not lead to a downturn in demand for core components and
products of the Company, in each of its operational segments.

Presented below is the Company's operational segment information. In addition,
all operational segments identified as "U.S." and Corporate are located within
the U.S. while the operations and assets of the "European Aerospace" segment are
located within the United Kingdom. Identifiable assets are those assets used in
the Company's operations in each segment, and do not include advances or loans
between the business segments. Corporate assets are identified below, and no
allocations were necessary for assets used jointly by the segments.

Year ended May 31, 1998:

<TABLE>
<CAPTION>
                                                                                    Corporate,
                                            U.S.        European        U.S.        other and
                                          Aerospace     Aerospace   Electronics    eliminations      Total
                                         ------------  ----------- -------------  --------------  ------------
  <S>                                    <C>           <C>                        <C>             <C>
  Net sales to customers                 $ 34,146,000           --    19,953,000              --    54,099,000
  Net sales between segments                  162,000           --         5,000        (167,000)           --
  Income (loss) from operations             4,665,000           --     2,454,000      (2,379,000)    4,740,000
  Identifiable assets                      29,761,000           --    28,943,000      19,876,000    78,580,000
  Capital expenditures                      4,212,000           --     1,333,000       4,745,000    10,290,000
  Depreciation and amortization             1,301,000           --       855,000          48,000     2,204,000
  Interest income                                  --           --        46,000          64,000       110,000
  Interest expense                            381,000           --       104,000         380,000       865,000
</TABLE>

                                      64                          (Continued)


<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000



   Year ended May 31, 1999:

<TABLE>
<CAPTION>
                                                                                            Corporate,
                                                   U.S.       European        U.S.          other and
                                                 Aerospace    Aerospace    Electronics    eliminations       Total
                                               ------------  -----------  -------------  --------------  ------------
     <S>                                       <C>           <C>          <C>            <C>             <C>
     Net sales to customers                    $ 31,096,000   52,814,000     23,456,000              --   107,366,000
     Net sales between segments                     239,000           --             --        (239,000)           --
     Income (loss) from operations                2,148,000    7,468,000     (6,220,000)     (4,371,000)     (975,000)
     Identifiable assets                         26,655,000   90,125,000     21,735,000      20,212,000   158,727,000
     Capital expenditures                         2,438,000    1,679,000      2,541,000       2,453,000     9,611,000
     Depreciation and amortization                1,659,000    3,170,000      1,684,000         192,000     6,779,000
     Interest income                                     --       17,000         19,000         496,000       532,000
     Interest expense                               419,000    3,516,000        202,000       4,535,000     8,672,000
</TABLE>

   Year ended May 31, 2000:

<TABLE>
<CAPTION>
                                                                                           Corporate,
                                                   U.S.       European        U.S.         other and
                                                 Aerospace    Aerospace    Electronics    eliminations       Total
                                               ------------  -----------  -------------  --------------  ------------
     <S>                                       <C>           <C>          <C>            <C>             <C>
     Net sales to customers                    $ 31,483,000   56,913,000     24,298,000              --   112,694,000
     Net sales between segments                     351,000           --             --        (351,000)           --
     Income (loss) from operations               (5,820,000)   2,628,000      6,245,000      (6,955,000)   (3,902,000)
     Identifiable assets                         32,553,000   75,585,000     23,018,000      12,426,000   143,582,000
     Capital expenditures                         1,518,000    1,254,000      1,300,000         795,000     4,867,000
     Depreciation and amortization                2,235,000    3,702,000      1,367,000         437,000     7,741,000
     Interest income                                     --       35,000             --          62,000        97,000
     Interest expense                               353,000    4,349,000        129,000       5,128,000     9,959,000
</TABLE>

     The Company had net sales to two customers, each comprising greater than
     10% of net sales, aggregating 45% in the year ended May 31, 1998. The
     Company had net sales to one customer comprising greater than 10% of net
     sales, aggregating 12% in the year ended May 31, 1999. The Company had net
     sales to one customer comprising an amount equal to 10% of net sales in the
     year ending May 31, 2000.

                                       65                            (Continued)


<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


     The Company had accounts receivable from one customer comprising greater
     than 10% of accounts receivable, aggregating 11% as of May 31, 1999. The
     Company had accounts receivable from two customers comprising greater than
     10% of accounts receivable, aggregating 11% and 12% as of May 31, 2000.

     Credit is extended to customers based on an evaluation of their financial
     condition and collateral is generally not required.

     The Company currently purchases aluminum and other raw materials from a
     limited number of suppliers. Although there are a limited number of
     potential suppliers of such raw materials, management believes that other
     suppliers could provide these raw materials on comparable terms. A change
     in suppliers, however, could cause a delay in manufacturing, increased
     costs, and a possible loss of sales, which could have a material adverse
     effect on the manufacturing and delivery of the Company's products. The
     Company purchased $2,723,000, $2,772,000 and $2,656,000 from one supplier
     during the years ended May 31, 1998, 1999 and 2000, respectively.

     The Company purchases other raw materials, of lesser significance, which
     are available from a limited number of suppliers.

     At May 31, 2000, the Company had purchase commitments for raw materials
     aggregating $4,240,000.

(6)  Business Acquisitions

     Effective for accounting purposes in February 1998, the Company acquired
     substantially all of the assets and assumed certain liabilities of PCC
     Composites, Inc.'s operating unit, Balo Precision Parts. The purchase price
     consisted of $2.25 million in cash and resulted in costs in excess of net
     book value of $1,029,000.

     Effective for accounting purposes in March 1998, the Company acquired
     substantially all assets and certain liabilities of Electronic Specialty
     Corporation and its wholly-owned subsidiary, Displays & Technologies, Inc.
     (collectively "ESC"). The purchase price consisted of $2.0 million in cash,
     923,304 shares of the Company's common stock valued at $6,109,000, and
     acquisition costs of $77,000 for a total of $8,186,000.

     The purchase price and related acquisition costs were allocated as follows:

     Current assets                                    $ 4,066,000
     Equipment                                           4,364,000
     Other noncurrent assets                                50,000
     Cost in excess of net book value                    3,631,000
     Liabilities assumed                                (3,925,000)
                                                       -----------
        Total                                          $ 8,186,000
                                                       ===========

                                       66                            (Continued)


<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


     During the year ended May 31, 1999, the Company made claims against the
     previous owner of ESC based on certain representations and warranties in
     the purchase agreement. In April 1999, the previous owner of ESC agreed to
     return 225,000 of the Company's common shares previously received in the
     acquisition.

     In July 1998, the Company purchased all of the outstanding stock of Aeromet
     International PLC ("Aeromet"). The purchase price consisted of
     (Pounds)42,000,000 (approximately $68,875,000) in cash and acquisition
     costs of $542,000 for a total of $69,417,000.

     The purchase price and related acquisition costs were allocated as follows:

               Current assets                            $ 27,529,000
               Equipment                                   18,177,000
               Cost in excess of net book value            39,884,000
               Liabilities assumed                        (16,173,000)
                                                         ------------

                      Total                              $ 69,417,000
                                                         ============

     Effective for accounting purposes in June 1999, the Company acquired all of
     the outstanding stock of Skagit Engineering & Manufacturing, Inc.
     ("Skagit") for $1,300,000 in cash.

     The purchase price was allocated as follows:

               Current assets                            $  1,551,000
               Property, plant and equipment                1,369,000
               Cost in excess of net book value             1,683,000
               Liabilities assumed                         (3,303,000)
                                                         ------------

                      Total                              $  1,300,000
                                                         ============

     Effective for accounting purposes in May 2000, the Company acquired
     substantially all of the assets and assumed certain liabilities of Nova-
     Tech Engineering, Inc. ("Nova-Tech"). The purchase price consisted of
     $2,500,000 in the forgiveness of a note receivable, intercompany accounts
     receivable of $137,000, and $50,000 cash for a total of $2,687,000.

     The purchase price was allocated as follows:

               Current assets                            $    873,000
               Furniture and equipment                        387,000
               Cost in excess of net book value             3,938,000
               Liabilities assumed                         (2,511,000)
                                                         ------------

                      Total                              $  2,687,000
                                                         ============

                                       67                           (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements
                             May 31, 1999 and 2000

     The business combinations described above have been accounted for using the
     purchase method. Accordingly, assets and liabilities have been recorded at
     their fair value at acquisition date. Operating results of these acquired
     companies are included in the Company's consolidated statements of
     operations from the respective acquisition dates. In fiscal year 2000,
     subsequent to the business combinations, costs in excess of net book value
     of acquired subsidiaries in the amounts of $1,000,000 of goodwill relating
     to Skagit and $2,400,000 relating to Nova-Tech, were written off due to
     impairment. In fiscal year 1999, costs in excess of net book value in the
     amount of $2,033,000 of goodwill relating to ESC were written off due to
     impairment. Amounts written off are included in operating expense.

     The following summary, prepared on a pro forma basis, presents the
     unaudited consolidated condensed results of operations of the Company, as
     if the fiscal years 1999 and 2000 business acquisitions were made as of the
     first day of the immediately preceding fiscal year in which the entities
     were acquired. There are no material adjustments which impact the summary.

<TABLE>
<CAPTION>
                                                                               Year ended May 31
                                                                                  (unaudited)
                                                                         -----------------------------
                                                                             1999              2000
                                                                         ------------     ------------
          <S>                                                            <C>              <C>
          Net sales                                                      $133,623,000      117,965,000
          Income (loss) from operations                                     1,846,000      (11,457,000)
          Net income (loss)                                               (15,863,000)     (17,302,000)
          Net income (loss) per share:
           Basic                                                                (0.91)           (0.79)
           Diluted                                                              (0.91)           (0.79)

          Shares used in computation of net income (loss) per share:
             Basic                                                         17,359,491       21,955,473
             Diluted                                                       17,359,491       21,955,473
</TABLE>

     The pro forma results are not necessarily indicative of the actual results
     of operations that would have occurred had the transactions been
     consummated as of the date indicated nor are they intended to indicate
     results that may occur in the future.

                                       68                            (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements
                             May 31, 1999 and 2000

(7)  Inventories

     Inventories at May 31 consist of the following:

<TABLE>

                                                                         1999                 2000
                                                                    -------------     -------------
          <S>                                                       <C>               <C>
          Raw materials                                             $   7,374,000         7,176,000
          Work in progress                                             11,478,000        13,580,000
          Finished goods                                                5,764,000         7,092,000
                                                                    -------------     -------------

                                                                    $  24,616,000        27,849,000
                                                                    =============     =============
</TABLE>

(8)  Property, Plant and Equipment

     Property, plant and equipment, including assets under capital lease
     arrangements, at May 31 consist of the following:

<TABLE>
                                                                       1999              2000
                                                                  -------------     -------------
          <S>                                                     <C>               <C>
          Land                                                    $   2,028,000         2,046,000
          Buildings                                                   8,765,000         8,687,000
          Leasehold improvements                                      2,285,000         3,509,000
          Machinery and equipment                                    38,687,000        52,213,000
          Furniture and fixtures                                      3,099,000         2,998,000
                                                                  -------------     -------------
                                                                     54,864,000        69,453,000
          Less accumulated depreciation and amortization             10,295,000        26,301,000
                                                                  -------------     -------------
                                                                     44,569,000        43,152,000
          Construction and purchases in progress                        710,000           924,000
                                                                  -------------     -------------

                                                                  $  45,279,000        44,076,000
                                                                  =============     =============
</TABLE>

     The Company recognized depreciation of property, plant and equipment of
     $1,851,000, $5,448,000 and $5,941,967 during the years ended May 31, 1998,
     1999 and 2000, respectively.

     Included in property, plant and equipment are costs of $3,244,000 and
     $5,874,479 and related accumulated amortization of $893,000 and $1,049,000
     recorded under capital leases at May 31, 1999 and 2000, respectively.

     In December 1998, the Company entered into an agreement giving it the
     option to purchase three parcels of land that make up the Wenatchee campus
     for $5.4 million. The purchase of the first parcel was completed in early
     February 1999. If the Company exercises its options to purchase both of the
     remaining two parcels, the purchase of the second parcel is expected to
     close in December 2000 and the third is expected to close in August 2001.

                                       69                            (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements
                             May 31, 1999 and 2000

(9)  Credit Facility

     The Company has a credit facility with a bank consisting of (a) a revolving
     working capital line of credit of up to $6,300,000 which expires in
     September 2000 (the "Line of Credit"), (b) a capital equipment acquisition
     credit facility of up to $2,000,000 which expires in June 2008 (the
     "Equipment Line"), and (c) a term loan of approximately $700,000 which
     expires in March 2008 (the "Construction Loan"). As of May 31, 2000, the
     Line of Credit had an outstanding balance of $5,379,000, the Equipment Line
     had an outstanding balance of $1,156,000 and the Construction Loan had an
     outstanding balance of $658,000. Borrowings under the credit facilities
     bear interest at variable rates ranging from 8.2% to 9.5% at May 31, 2000,
     and are secured by inventories, accounts receivable, and certain equipment
     and building improvements. The agreement contains restrictive covenants
     related to working capital, net worth and debt service coverage. Management
     believes the Company is in compliance with these covenants at May 31, 2000.

     The Company also has a (Pounds)3,500,000 line of credit with a bank in the
     U.K. which expires in November 2000. Borrowings under the line of credit
     bear interest at variable rates. At May 31, 2000, there were no borrowings
     outstanding on the line of credit.

     The Company is currently in negotiations with its lenders to renew these
     credit facilities. If the Company is unable to extend the lines of credit,
     or if borrowing limits are decreased, or if suitable alternative sources of
     financing are not obtained, it could have a material adverse effect on the
     Company's financial position, results of operations and its ability to
     continue in existence.

     In connection with the acquisition of Nova-Tech, the Company assumed a
     revolving working capital line of credit. The outstanding balance was
     repaid in full and was not renewed.

                                       70                            (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements
                             May 31, 1999 and 2000

(10) Long-Term Debt

     Long-term debt at May 31 consists of the following:

<TABLE>
                                                                                             1999              2000
                                                                                         ------------     -------------
     <S>                                                                                 <C>              <C>
     Industrial revenue bond payable to a bank in monthly installments of $19,200,
      including interest at 8.12%, through July 2004                                     $   961,000          787,000

     Note payable to a bank in monthly installments of $7,000, including interest
      at LIBOR plus 2% (8.65% at May 31, 2000), with the remaining principal
      balance due in full in March 2008                                                      685,000          658,000

     Subordinated note payable to the City of Entiat in monthly installments of
      $7,300, including interest at 8%, with the principal balance due in full in
      May 2001                                                                               457,000          410,000

     Note payable to bank in monthly principal installments of $5,000 plus interest
      at the 30-day commercial paper rate plus 3.25% (9.82% at May 31, 2000)
      through March 31, 2003                                                                 205,000          145,000

     Notes payable to a financing company for certain equipment in aggregate
      monthly installments of $58,000, including interest at 9% to 10.9%, with
      maturity dates through 2004                                                          2,220,000        1,701,000

     Other notes payable for vehicles and certain equipment in aggregate monthly
      installments of $22,000, including interest at 1.9% to 10.5% with maturity
      dates through December 2003                                                            786,000          402,000

     Note payable to a bank in monthly installments of $10,127, including interest
      at LIBOR plus 2.25% (8.90% at May 31, 2000) through June  2008                       1,184,000        1,156,000
                                                                                         -----------     ------------
                                                                                           6,498,000        5,259,000
     Less current portion                                                                  1,278,000        1,098,000
                                                                                         -----------     ------------
           Long-term debt, net of current portion                                        $ 5,220,000        4,161,000
                                                                                         ===========     ============
</TABLE>

     The industrial revenue bond agreement and a certain note payable to a bank
     require, among other items, that the Company maintain minimum working
     capital, tangible net worth and debt to tangible net worth ratios.
     Management believes the Company is in compliance with these covenants at
     May 31, 2000.

                                       71                            (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements
                             May 31, 1999 and 2000

     Scheduled principal maturities of long-term debt at May 31, 2000 are as
     follows for each of the following fiscal year-ends:

<TABLE>
          <S>                                           <C>
          2001                                          $ 1,098,000
          2002                                              993,000
          2003                                              863,000
          2004                                              602,000
          2005                                              157,000
          Thereafter                                      1,546,000
                                                        -----------

                                                        $ 5,259,000
                                                        ===========
</TABLE>

     Long-term debt is secured by substantially all assets of the Company and,
     in certain circumstances, through personal guarantees of certain
     stockholders.

(11) Senior Subordinated Notes Payable

     In July 1998, the Company completed a $75 million debt offering of 11 1/4%
     Senior Subordinated Notes (the "Notes") due in August 2005 (the
     "Offering"). The Notes are unconditionally guaranteed on a senior
     subordinated basis by the Company's U.S. subsidiaries. The net proceeds
     from the Offering were used to finance the acquisition of Aeromet.

     Interest on the Notes is payable semiannually on February 1 and August 1 of
     each year. The Notes may be redeemable at the option of the Company, in
     whole or in part, on or after August 1, 2003 at the redemption price as
     defined in the agreement. In addition, on or before August 1, 2001, the
     Company may redeem up to 20% of the Notes at a redemption price of 111.25%
     of the principal amount plus accrued and unpaid interest.

     Under provisions of the indenture applicable to the Notes, the Company is
     limited in its ability to incur additional indebtedness or issue
     Disqualified Capital Stock, pay dividends or make other distributions,
     create certain liens on assets, sell certain assets and stock of
     subsidiaries, enter into certain transactions with affiliates, and effect
     certain mergers and consolidations. The Company is also subject to certain
     restrictive covenants and is required to maintain certain financial ratios
     in connection with the Notes. Management believes the Company is in
     compliance with these covenants at May 31, 2000.

     In March 2000, the Company exchanged an aggregate of $11.3 million in
     original principal amount of the Notes for a total of 2,902,806 shares of
     common stock. This exchange was accounted for as an early extinguishment of
     debt, and as such, a net of tax gain of $703,000 has been recorded in the
     financial statements as an extraordinary item.

                                       72                            (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONIC, INC.
                               AND SUBSIDIARIES

                  Noted to Consolidated Financial Statements

                             May 31, 1999 and 2000


(12) Leasing Arrangements

     (a)  Capital Leases

          The Company leases certain property, plant and equipment under capital
          lease agreements that expire at various dates through 2008. Capital
          lease obligations are secured by the underlying leased assets.
          Aggregate minimum payments to be made under these agreements at May
          31, 2000 are as follows for each of the following fiscal year-ends:

<TABLE>
               <S>                                                                <C>
               2001                                                               $      565,000
               2002                                                                      369,000
               2003                                                                      303,000
               2004                                                                      281,000
               2005                                                                      209,000
               Thereafter                                                                174,000
                                                                                  --------------
                                                                                       1,901,000
               Less amounts representing interest ranging from 6% to 16%                 332,000
                                                                                  --------------
                    Present value of net minimum capital lease obligations             1,569,000
               Less current portion                                                      504,000
                                                                                  --------------
                    Capital lease obligations, less current portion               $    1,065,000
                                                                                  ==============
</TABLE>


     (b)  Operating Leases

          The Company leases certain property, plant and equipment under
          operating lease agreements that expire at various dates through 2018.
          Aggregate minimum rental payments to be made under these agreements at
          May 31, 2000 are as follows for each of the following fiscal year-
          ends:

<TABLE>
              <S>                                                                 <C>
               2001                                                               $    4,191,000
               2002                                                                    3,523,000
               2003                                                                    3,375,000
               2004                                                                    2,608,000
               2005                                                                    2,419,000
               Thereafter                                                             23,854,000
                                                                                  --------------
                                                                                  $   39,970,000
                                                                                  ==============
</TABLE>

          Total rent expense during the years ended May 31, 1998, 1999 and 2000
          amounted to $788,000, $3,356,000 and $4,191,000, respectively.

                                       73                            (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONIC, INC.
                               AND SUBSIDIARIES

                  Noted to Consolidated Financial Statements

                             May 31, 1999 and 2000


(13) Common Stock

     In July 1996, the Company conducted a public offering of 2,250,000 units,
     each unit composed of one share of the Company's common stock and a warrant
     to purchase a share of the Company's common stock, at a price of $3.125 per
     unit. At May 31, 1999 and 2000, all of these public warrants were
     outstanding. In May 2000, the Company extended the expiration date of the
     public warrants to July 15, 2003. In addition, the Company issued warrants
     to two underwriters for the purchase of an additional 225,000 units at
     $3.75 per unit. Each unit is composed of one share of the Company's common
     stock and a warrant to purchase one share of the Company's common stock.
     The warrants entitled the holder to purchase one share of common stock at
     $4.6875 per share, exercisable any time through July 2001. During the year
     ended May 31, 1998, 45,000 of the underwriters' warrants were exercised for
     45,000 units. No underwriter warrants were exercised during the years ended
     May 31, 1999 and 2000.

     In November 1997, the Company closed a private offering of $6,408,000,
     before expenses of $320,000, in common stock and notes payable to three
     accredited investors. The Company subsequently filed a registration
     statement, which was declared effective, registering for resale the 524,000
     shares of common stock sold in the offering. The outstanding balance of the
     notes payable was repaid in full during the year ended May 31, 1999.

     In November 1998, the Company sold 2,585,000 shares of its common stock in
     a private offering to institutional investors. Proceeds from the offering
     totaled $5,170,000 before expenses of $344,000.

     In March 2000, the Company sold 1,598,000 shares of its common stock to 26
     accredited investors for $4,794,000 before expenses of $788,000. The
     Company subsequently filed a registration statement, which was declared
     effective, registering for resale the 1,598,000 shares of common stock sold
     in the offering.

(14) Convertible Preferred Stock

     (a)  Series A Convertible Preferred Stock

          In February 1997, the Company sold 50,000 shares of Series A
          convertible preferred stock (Series A) in a private placement for
          $5,000,000, and incurred related offering costs of $519,000, resulting
          in net proceeds of $4,481,000. At May 31, 1998, all of the shares of
          Series A had been converted into 1,494,593 shares of common stock.

     (b)  Series B Convertible Preferred Stock

          In May 1998, the Company sold 100,000 shares of Series B convertible
          preferred stock (Series B) for $100 per share, and issued warrants to
          purchase 138,888 shares of common stock, in a private offering, which
          resulted in gross proceeds of $10.0 million, less related offering
          costs of $740,000 for net proceeds of $9,260,000. In addition, the
          purchasers deposited $7.0 million in an escrow account which,
          subsequent to the closing of the purchase of Aeromet, was exchanged by
          the Company for 70,000 additional shares of Series B and additional
          warrants to purchase 97,221 shares

                                       74                            (Continued)

<PAGE>

                     PACIFIC AEROSPACE & ELECTRONIC, INC.
                               AND SUBSIDIARIES

                  Noted to Consolidated Financial Statements

                             May 31, 1999 and 2000


          of common stock. Net proceeds to the Company, subsequent to offering
          costs of $370,000, were $6,630,000.

          Upon conversion of shares of Series B, the holder will receive the
          number of shares of common stock equal to $100 divided by the then
          applicable conversion price of the Series B. The conversion price of
          the Series B at May 31, 2000 is equal to the lower of (a) $7.20 per
          share, or (b) the average of the three lowest closing bid prices per
          share of the common stock over the 22 trading days before conversion.
          No holder of Series B is entitled to voluntarily convert Series B that
          would cause the holder to own more than 9.9% of the Company's total
          outstanding common stock at any one time. Any Series B outstanding on
          May 2003 will be automatically converted into common stock at the
          then-applicable conversion price.

          Series B has a liquidation preference equal to the greater of the sum
          of $100 per Series B share and any declared but unpaid dividends or
          the amount the holder would be entitled to if the Series B were
          converted to common stock at the then applicable conversion rate.
          Dividends on Series B are based on the discretion of the board of
          directors and no dividends on the Series B have been declared or paid
          as of May 31, 2000. If a dividend is declared or paid on common stock,
          other than in shares of common stock, Series B holders are entitled to
          a dividend per share of Series B equal to the amount which would be
          received as if the Series B were converted to common stock at the then
          applicable conversion rate. The Company may redeem the Series B at a
          redemption price of $115 per share under certain circumstances.

          As of May 31, 1999 and 2000, 8,965 and 135,471 shares, respectively,
          of Series B have been converted into 545,114 and 7,227,454 shares,
          respectively, of common stock.

(15) Warrants

     The Company periodically issues warrants to purchase common shares in
     connection with common stock, preferred stock, debt and certain consulting
     services. A summary of the Company's warrants, excluding warrants issued in
     connection with the public offering in July 1996, is as follows:

<TABLE>
<CAPTION>
                                                                  Weighted
                                                                average price
                                                   Warrants       of shares
                                                ------------   --------------
          <S>                                   <C>            <C>
          Balance at May 31, 1997                    497,500   $         4.34
          Granted                                  1,928,888             4.74
          Exercised                                 (750,000)            4.61
                                                ------------   --------------
          Balance at May 31, 1998                  1,676,388             4.36
          Granted                                     97,221             7.20
          Canceled                                (1,290,000)            4.62
                                                ------------   --------------
          Balance at May 31, 1999                    483,609             4.24
          Granted                                    200,000             6.50
          Exercised                                  (25,000)            3.45
                                                ------------   --------------
          Balance at May 31, 2000                    658,609   $         4.96
                                                ============   ==============
</TABLE>

                                       75                            (Continued)
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONIC, INC.
                               AND SUBSIDIARIES

                  Noted to Consolidated Financial Statements

                             May 31, 1999 and 2000



     The following summarizes warrants outstanding, excluding warrants issued in
     connection with the public offering in July 1996, at May 31, 2000:

<TABLE>
<CAPTION>
                          Warrants outstanding and exercisable
                     -----------------------------------------------
                                          Weighted
                                           average        Weighted
        Range of                          remaining       average
        Exercise          Number         contractual      exercise
         prices        outstanding           life           price
     --------------  ---------------   ---------------  ------------
     <S>             <C>                <C>             <C>
     $ 2.00 -  4.00         235,000       3.39 years       $ 2.47
       4.01 -  6.00          87,500       2.53 years         5.20
       6.01 -  8.00         286,109       3.81 years         7.25
       8.01 - 10.00          50,000       2.92 years         9.50
                     --------------
                            658,609
                     ==============
</TABLE>


(16) Compensation Plans

     (a)  Long-Term Investment and Incentive Plan

          The Company has two long-term stock investment and incentive plans.
          The "1996 Plan" awards directors, officers, key employees and other
          key individuals with stock options, stock appreciation rights, stock
          and cash bonuses, restricted stock, or performance units. Under the
          1996 Plan, the exercise price of options issued is not less than fair-
          market value at the date of grant. In October 1999, the Company
          adopted the "1999 Plan" which effectively reserved an additional
          4,000,000 shares of common stock for issuance. The 1999 Plan is
          identical to the 1996 Plan in form with exception to certain
          provisions stipulating the expiration of options granted to employees
          who are subsequently terminated. Options expire ten years from the
          grant date under both plans.

          As of May 31, 1999 and 2000, the Company had not issued any stock
          appreciation rights, stock and cash bonuses, restricted stock, or
          performance units under either plan.

                                       76                            (Continued)

<PAGE>

                     PACIFIC AEROSPACE & ELECTRONIC, INC.
                               AND SUBSIDIARIES

                  Noted to Consolidated Financial Statements

                             May 31, 1999 and 2000


     As the Company applies APB Opinion No. 25 and related interpretations in
     accounting for its option plans, no compensation costs have been recognized
     for stock options issued to employees. Had compensation costs for stock
     options been determined consistent with SFAS No. 123, the results of the
     Company would have been adjusted to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                  1998            1999             2000
                                              ------------    ------------     ------------
     <S>                                      <C>             <C>              <C>
     Net income (loss):
      As reported                             $  3,614,000    (12,869,000)     (13,049,000)
      Pro forma                                  2,478,000    (14,962,000)     (14,477,000)
     Net income (loss) per share:
      As reported:
        Basic                                         0.29          (0.74)           (0.59)
        Diluted                                       0.27          (0.74)           (0.59)
      Pro forma:
        Basic                                         0.20          (0.86)           (0.66)
        Diluted                                       0.18          (0.86)           (0.66)
     Shares used in computation of
      net income (loss) per share:
        Basic                                   12,486,077     17,359,491       21,955,473
        Diluted                                 13,606,061     17,359,491       21,955,473
</TABLE>

     The fair value of the options granted during 1998, 1999 and 2000 is
     estimated as $3,007,000, $474,340 and $1,253,000, respectively, using the
     Black-Scholes option-pricing model with the following assumptions on the
     date of grant: zero percent dividend yield, expected volatility from 24% to
     122%, risk-free interest rate from 5.5% to 6.6%, and expected lives ranging
     from 5 to 10 years.

     In December 1998, the Company repriced certain options to purchase
     1,466,056 shares to a lower exercise price. The repricing resulted in
     additional compensation costs under SFAS No. 123 of $352,000, which are
     included in the pro forma amounts disclosed above.

                                       77                           (Continued)

<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


      A summary of the Company's stock option plans is as follows:

<TABLE>
<CAPTION>
                                                                          Shares of common stock
                                                               -----------------------------------------         Weighted
                                                                    Available              Options             average price
                                                                     options              under plan             of shares
                                                               ------------------     ------------------     ------------------
          <S>                                                 <C>                    <C>                     <C>
          Balance at May 31, 1997                                         856,384              1,143,616     $             4.61

          Authorized                                                    1,000,000                     --                     --
          Granted                                                      (1,112,500)             1,112,500                   5.49
          Exercised                                                            --                (25,000)                  2.11
                                                               ------------------     ------------------     ------------------
          Balance at May 31, 1998                                         743,884              2,231,116                   5.09

          Granted                                                      (1,804,388)             1,804,388                   2.51
          Expired                                                          30,000                (30,000)                  2.00
          Canceled                                                      1,466,056             (1,466,056)                 (3.70)
          Terminations                                                     72,500                (72,500)                  6.13
                                                               ------------------     ------------------     ------------------
          Balance at May 31, 1999                                         508,052              2,466,948                   3.32

          Authorized by new plan                                        4,000,000                     --                     --
          Granted                                                        (910,000)               910,000                   1.64
          Terminated                                                        5,000                 (5,000)                  2.53
                                                               ------------------     ------------------     ------------------
          Balance at May 31, 2000                                       3,593,052              3,371,948     $             1.64
                                                               ==================     ==================     ==================
</TABLE>

      The following summarizes options from both plans outstanding at May 31,
2000:

<TABLE>
<CAPTION>
                                         Options outstanding                                  Options exercisable
                     -----------------------------------------------------------     -------------------------------------
                                               Weighted
                                                average             Weighted                                  Weighted
 Range of                                      remaining             average                                   average
 exercise                  Number             contractual           exercise               Number             exercise
  prices                outstanding              life                 price             exercisable             price
--------------       -----------------     -----------------     ---------------     -----------------     ---------------
<S>                 <C>                   <C>                   <C>                 <C>                   <C>
$0.01 - 1.99                   880,000                  9.45   $            1.60               880,000   $            1.60
 2.00 - 3.99                 1,884,388                  7.53                2.51             1,745,222                2.52
 4.00 - 6.00                   607,560                  6.21                4.69               607,560                4.69
                     -----------------                                               -----------------
                             3,371,948                                                       3,232,782
                     =================                                               =================
</TABLE>

                                                                     (Continued)

                                       78
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


      (b)   Independent Director Stock Plan

            The Company has an Independent Director Stock Plan under which
            nonemployee directors of the Company are awarded common stock and
            stock options of the Company for serving on its board of directors.
            The plan authorizes and reserves for issuance a maximum of 500,000
            common shares. At May 31, 1999 and 2000, 420,804 and 380,804 shares,
            respectively, were available for future issuance. During the year
            ended May 31, 1998, 8,559 shares of the Company's common stock were
            issued under the plan. During the year ended May 31, 1999, 600
            shares and 56,637 options were issued under the plan. During the
            year ended May 31, 2000, 40,000 options were issued and 10,000
            options were canceled under the plan. Options issued under the plan
            during the years ended May 31, 1999 and 2000 vested immediately upon
            issuance. Included in compensation expense are $13,000 and $89,000
            for the years ended May 31, 1998 and 1999, respectively, resulting
            from the shares issued. For the years ended May 31, 1999 and 2000,
            56,637 and 86,637 options were outstanding.

      (c)   Retirement Plan

            The Company maintains a 401(k) plan covering all eligible employees
            who meet service requirements as provided in the plan. Company
            contributions to the profit-sharing plan are determined annually by
            the Board of Directors. The Company contributed $27,000, $48,000 and
            $59,000 to the plan during the years ended May 31, 1998, 1999 and
            2000, respectively.

      (d)   Employee Stock Purchase Plan

            The Company implemented an Employee Stock Purchase Plan in 1999
            under which employees are eligible to purchase shares of the
            Company's common stock, through payroll deductions, at the lower of
            85% of the Company's stock price on the first day of an offering
            period or 100% of the Company's stock price on the last day of an
            offering period. The first offering period began in November 1998.
            During the years ended May 31, 1999 and 2000, 41,942 and 142,696
            shares, respectively, were purchased by employees under the plan.

(17)  Other Income and Expense

      Included in other income and expense during the year ended May 31, 1999
      are other than temporary unrealized losses related to the Company's
      investment in shares of a public company of $4,943,000 as well as
      allowances totaling $2,884,000 related to the Company's guarantees of
      certain debt and a reserve for the outstanding note receivable.

                                                                     (Continued)

                                       79
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


(18)  Income Taxes

      Total income tax benefit (expense) is as follows:

<TABLE>
<CAPTION>
                                                                         1998                   1999                   2000
                                                                  -----------------      -----------------      -----------------
          <S>                                                   <C>                     <C>                    <C>
          Current:
           Federal                                              $          (593,000)               262,000                     --
           Foreign                                                               --             (1,422,000)               (41,800)
          Deferred:
           Federal                                                        1,075,000              3,799,000                 (8,000)
           Foreign                                                               --                     --                 28,800
                                                                  -----------------      -----------------      -----------------
               Total                                            $           482,000              2,639,000                (21,000)
                                                                  =================      =================      =================
</TABLE>

      The domestic and foreign components of income (loss) before income tax
      benefit (expense) were as follows:

<TABLE>
<CAPTION>
                                                                         1998                  1999                   2000
                                                                  -----------------     -----------------      -----------------
          <S>                                                  <C>                     <C>                    <C>
          Domestic                                              $         3,132,000           (18,992,000)           (11,421,000)
          Foreign                                                                --             3,484,000             (2,310,000)
                                                                  -----------------     -----------------      -----------------
               Income (loss) before income tax benefit
                (expense)                                       $         3,132,000           (15,508,000)           (13,731,000)
                                                                  =================     =================      =================
</TABLE>

      Undistributed earnings of the Company's foreign subsidiaries for which no
      U.S. income taxes have been provided aggregates approximately $3,700,000
      and $0 at May 31, 1999 and 2000, respectively. No provision for foreign
      withholding or U.S. federal income taxes was made for the undistributed
      earnings, as it is management's intention that earnings will be reinvested
      indefinitely in foreign operations or will be remitted substantially free
      of additional taxes.

      A reconciliation of the U.S. federal statutory tax rate of 34% and the
      Company's effective tax rates of 15%, 17% and 0% in the years ended May
      31, 1998, 1999 and 2000, respectively, is as follows:

<TABLE>
<CAPTION>
                                                                      1998                   1999                   2000
                                                                -----------------      -----------------      -----------------
          <S>                                                <C>                      <C>                    <C>
          Computed expected income tax
            benefit (expense)                                 $        (1,065,000)             5,273,000              4,669,000
          Change in valuation allowance                                 1,717,000             (2,200,000)            (4,119,000)
          Other                                                          (170,000)              (434,000)              (571,000)
                                                                -----------------      -----------------      -----------------
                                                              $           482,000              2,639,000                (21,000)
                                                                =================      =================      =================
</TABLE>

                                                                     (Continued)

                                       80
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


      Significant components of the Company's deferred tax assets (liabilities)
      at May 31 are as follows:

<TABLE>
<CAPTION>
                                                                   1999              2000
                                                               -------------    -------------
          <S>                                                  <C>              <C>
          Deferred tax assets:
           NOL carryforward                                    $   4,427,000        6,493,000
           Unrealized capital loss                                 1,532,000        1,550,000
           Goodwill                                                       --        2,408,000
           Other                                                   1,550,000        1,429,000
           Translation adjustment                                    587,000               --
           Valuation allowances                                   (2,200,000)      (6,322,000)
                                                               -------------    -------------
                                                                   5,309,000        5,558,000
          Deferred tax liabilities - depreciation                 (1,034,000)      (2,383,000)
                                                               -------------    -------------
                Net deferred tax asset                         $   4,275,000        3,175,000
                                                               =============    =============
</TABLE>

     The Company has net operating loss (NOLs) carryforwards for U.S. federal
     income tax purposes of approximately $18,300,000, the benefits of which
     expire in the tax year 2001 through the tax year 2020.

     The NOLs created by the Company's subsidiaries prior to their acquisition
     and the NOLs created as a consolidated group or groups subsequent to a
     qualifying tax free merger or acquisition, have limitations related to the
     amount of usage by each subsidiary or consolidated group as described in
     the Internal Revenue Code. As a result of these limitations, approximately
     $1,500,000 of the $18,300,000 total NOLs at May 31, 2000 will never become
     available.

     The Company's ability to realize the deferred tax assets is dependent on
     material increases in present levels of pretax income, primarily in the
     United States.

(19) Net Income (Loss) Per Share

     Basic net income (loss) share is computed on the basis of the weighted
     average number of common shares outstanding. Diluted net income (loss) per
     share is computed on the basis of the weighted average number of common
     shares outstanding, using the "if-converted" method, and outstanding stock
     options and warrants, using the "treasury stock" method.

     The components of basic and diluted net income (loss) per share at May 31
     were as follows:

<TABLE>
<CAPTION>
                                                                    1998              1999              2000
                                                                -------------    --------------    --------------
     <S>                                                        <C>              <C>               <C>
     Net income (loss) available for common shareholders        $   3,614,000       (12,869,000)      (13,049,000)
                                                                =============    ==============    ==============
     Average outstanding shares of common stock                    12,486,077        17,359,491        21,955,473
     Dilutive effect of:
      Warrants                                                        853,470                --                --
      Stock options                                                   266,514                --                --
                                                                -------------    --------------    --------------
     Common stock and common stock equivalents                     13,606,061        17,359,491        21,955,473
                                                                =============    ==============    ==============
</TABLE>

                                                                     (Continued)

                                       81
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000

<TABLE>
<CAPTION>
                                                       1998          1999            2000
                                                   -----------   -----------     -----------
     <S>                                           <C>           <C>             <C>
     Earnings (loss) per share:
      Basic                                        $      0.29         (0.74)          (0.59)
      Diluted                                             0.27         (0.74)          (0.59)
</TABLE>

     Options, warrants and convertible stock were not included in the
     calculation of net loss per share as they are anti-dilutive.

(20) Fair Value of Financial Instruments

     The Company's financial instruments include cash and cash equivalents,
     receivables, investment, accounts payable, accrued liabilities, and short
     and long-term borrowings. The fair value of these financial instruments
     approximates their carrying amounts based on current market indicators,
     such as prevailing interest rates, with the exception of the senior
     subordinated notes payable, which are currently trading at approximately
     60% of face value.

(21) Legal

     The Company is currently subject and party to various legal actions arising
     in the normal course of business. Management believes the ultimate
     liability, if any, arising from such claims or contingencies is not likely
     to have a material adverse effect on the Company's results of operations or
     financial condition.

     In the normal course of business, the Company disposes of potentially
     hazardous material which could result in claims related to environmental
     cleanup. The Company has not been notified of any related claims. The
     Company is subject to various other environmental and governmental
     regulations. Although the extent of any noncompliance with those
     regulations, if any, is not completely ascertainable, management believes
     the ultimate liability is not likely to have a material adverse effect on
     the Company's results of operations or financial condition.

(22) Consolidating Condensed Financial Statements

     The following statements present consolidating condensed financial
     information of the Company for the indicated periods. The Company's senior
     subordinated notes, which were to finance the Aeroment acquisition in July
     1998, have been guaranteed by all of the Company's U.S. wholly owned
     subsidiaries. The guarantor subsidiaries have fully and unconditionally
     guaranteed this debt on a joint and several basis. This debt is not
     guaranteed by the Company's foreign subsidiaries, which consist of Aeroment
     and two related holding companies. There are no significant contractual
     restrictions on the distribution of funds from the guarantor subsidiaries
     to the parent corporation. The consolidating condensed financial
     information is presented in lieu of separate financial statements and other
     disclosures of the guarantor subsidiaries, as management has determined
     that such information is not material to investors.

                                                                     (Continued)
                                       82
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000

(a)  Consolidating condensed balance sheet information at May 31, 1999 is as
follows:

<TABLE>
<CAPTION>
                                                                           Guarantor   Non-guarantor
               Assets                                       Parent       subsidiaries   subsidiaries     Eliminations   Consolidated
                                                         --------------  ------------  --------------   --------------  ------------
<S>                                                      <C>             <C>           <C>              <C>             <C>
  Current assets:
    Cash and cash equivalents                            $   1,798,000        38,000      6,298,000             --        8,134,000
    Accounts receivable, net                                      --       8,723,000     16,661,000         (392,000)    24,992,000
    Inventories                                                   --      13,564,000     11,052,000             --       24,616,000
    Other                                                    4,535,000     1,517,000        660,000       (3,516,000)     3,196,000
                                                         --------------  ------------  --------------   --------------  ------------
           Total current assets                              6,333,000    23,842,000     34,671,000       (3,908,000)    60,938,000
                                                         --------------  ------------  --------------   --------------  ------------
  Property, plant and equipment, net                         6,151,000    21,930,000     17,198,000             --       45,279,000
                                                         --------------  ------------  --------------   --------------  ------------
  Other assets:
    Costs in excess of net book value of acquired
      subsidiaries, net                                           --       2,717,000     38,335,000             --       41,052,000
    Investment in subsidiaries                              53,228,000          --             --        (53,228,000)          --
    Intercompany note and loan receivable                   61,869,000          --           85,000      (61,954,000)          --
    Other                                                    8,327,000     3,296,000       (163,000)          (2,000)    11,458,000
                                                         --------------  ------------  --------------   --------------  ------------
           Total other assets                              123,424,000     6,013,000     38,257,000     (115,184,000)    52,510,000
                                                         --------------  ------------  --------------   --------------  ------------
           Total assets                                  $ 135,908,000    51,785,000     90,126,000     (119,092,000)   158,727,000
                                                         ==============  ============  ==============   ==============  ============

  Liabilities and Stockholders' Equity

  Current liabilities:
    Accounts payable                                     $     180,000     2,541,000      8,155,000         (392,000)    10,484,000
    Current portion of long-term debt                          137,000     1,141,000           --               --        1,278,000
    Other                                                    5,084,000     1,597,000      7,682,000       (3,516,000)    10,847,000
                                                         --------------  ------------  --------------   --------------  ------------
           Total current liabilities                         5,401,000     5,279,000     15,837,000       (3,908,000)    22,609,000
                                                         --------------  ------------  --------------   --------------  ------------
  Long-term liabilities:
    Long-term debt, net of current portion                  76,375,000     3,845,000           --               --       80,220,000
    Intercompany loan payable                                   85,000    24,369,000     37,500,000      (61,954,000)          --
    Other                                                       28,000     1,105,000        746,000             --        1,879,000
                                                         --------------  ------------  --------------   --------------  ------------
           Total long-term liabilities                      76,488,000    29,319,000     38,246,000      (61,954,000)    82,099,000
                                                         --------------  ------------  --------------   --------------  ------------
  Stockholders' equity (deficit):
    Convertible preferred stock                                   --            --             --               --             --
    Common stock                                                19,000    21,141,000     35,117,000      (56,258,000)        19,000
    Additional paid-in capital                              69,276,000          --             --               --       69,276,000
    Accumulated other comprehensive loss                    (1,140,000)         --       (1,136,000)       1,136,000     (1,140,000)
    Retained earnings (accumulated deficit)                (14,136,000)   (3,954,000)     2,062,000        1,892,000    (14,136,000)
                                                         --------------  ------------  --------------   --------------  ------------
           Total stockholders' equity                       54,019,000    17,187,000     36,043,000      (53,230,000)    54,019,000
                                                         --------------  ------------  --------------   --------------  ------------
           Total liabilities and stockholders' equity    $ 135,908,000    51,785,000     90,126,000     (119,092,000)   158,727,000
                                                         ==============  ============  ==============   ==============  ============
                                                                                                                         (Continued)
</TABLE>

                                       83
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000

(b) Consolidating condensed balance sheet information at May 31, 2000 is as
follows:

<TABLE>
<CAPTION>
                                                                          Guarantor     Non-guarantor
               Assets                                        Parent      subsidiaries   subsidiaries   Eliminations   Consolidated
                                                         -------------   ------------   ------------   ------------   ------------
<S>                                                      <C>              <C>            <C>             <C>           <C>
  Current assets:
    Cash and cash equivalents                            $    (184,000)        58,000      2,280,000              --     2,154,000
    Accounts receivable, net                                        --      9,047,000     12,527,000        (364,000)   21,210,000
    Inventories                                                     --     17,307,000     10,542,000              --    27,849,000
    Other                                                      895,000      1,145,000        500,000              --     2,540,000
                                                         -------------    -----------    -----------     -----------   -----------
           Total current assets                                711,000     27,557,000     25,849,000        (364,000)   53,753,000
                                                         -------------    -----------    -----------     -----------   -----------
  Property, plant and equipment, net                         6,340,000     22,995,000     14,741,000              --    44,076,000
                                                         -------------    -----------    -----------     -----------   -----------
  Other assets:
    Costs in excess of net book value of
    acquired subsidiaries, net                                      --      3,296,000     34,995,000              --    38,291,000
    Investment in and loans to subsidiaries                111,792,000     72,618,000             --    (184,410,000)           --
    Other                                                    5,183,000      2,982,000       (703,000)             --     7,462,000
                                                         -------------    -----------    -----------     -----------   -----------
           Total other assets                              116,975,000     78,896,000     34,292,000    (184,410,000)   45,753,000
                                                         -------------    -----------    -----------     -----------   -----------
           Total assets                                  $ 124,026,000    129,448,000     74,882,000    (184,774,000)  143,582,000
                                                         =============    ===========    ===========     ===========   ===========
   Liabilities and Stockholders' Equity

Current liabilities:
    Accounts payable                                     $     667,000      3,729,000      6,598,000        (364,000)   10,630,000
    Current portion of long-term debt                          170,000        928,000             --              --     1,098,000
    Line of credit                                           5,379,000             --             --              --     5,379,000
    Other                                                    2,989,000      2,898,000      1,578,000              --     7,465,000
                                                         -------------    -----------    -----------        --------    ----------
           Total current liabilities                         9,205,000      7,555,000      8,176,000        (364,000)   24,572,000
                                                         -------------    -----------    -----------       ----------   ----------

  Long-term liabilities:
    Long-term debt, net of current portion                  64,928,000      2,933,000             --              --    67,861,000
    Intercompany loan payable                                       --     71,484,000     38,957,000    (110,441,000)           --
    Other                                                      125,000        706,000        550,000              --     1,381,000
                                                         -------------    -----------     ----------     -----------   -----------
           Total long-term liabilities                      65,053,000     75,123,000     39,507,000    (110.441,000)   69,242,000
                                                         -------------    -----------     ----------     -----------   -----------
  Stockholders' equity (deficit):
    Convertible preferred stock                                     --             --             --              --            --
    Common stock                                                30,000     56,139,000     33,710,000     (89,849,000)       30,000
    Additional paid-in capital                              83,173,000             --             --              --    83,173,000
    Accumulated other comprehensive loss                    (6,250,000)            --     (6,250,000)      6,250,000    (6,250,000)
    Accumulated deficit                                     27,185,000     (9,369,000)      (261,000)      9,630,000   (27,185,000)
                                                         -------------    -----------     ----------     -----------   -----------
           Total stockholders' equity                       49,768,000     46,770,000     27,199,000     (73,969,000)   49,768,000
                                                         -------------    -----------     ----------     -----------   -----------
           Total liabilities and stockholders' equity    $ 124,026,000    129,448,000     74,882,000    (184,774,000)  143,582,000
                                                         =============    ===========     ==========     ===========   ===========
                                                                                                                       (Continued)
</TABLE>

                                       84
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000

(c)  Consolidating  condensed  statement of operations  information for the year
ended May 31, 1998 is as follows:

<TABLE>
<CAPTION>
                                                                          Guarantor     Non-guarantor
                                                          Parent        subsidiaries    subsidiaries    Eliminations   Consolidated
                                                      --------------    ------------    -------------   ------------   ------------
<S>                                                   <C>               <C>             <C>             <C>            <C>
Net sales                                             $          --      54,968,000                --      (869,000)     54,099,000
Cost of sales                                                    --      40,356,000                --      (869,000)     39,487,000
                                                      -------------      ----------     -------------    ----------      ----------
           Gross profit                                          --      14,612,000                --            --      14,612,000

Operating expenses                                        2,378,000       9,373,000                --    (1,879,000)      9,872,000
                                                      -------------      ----------     -------------    ----------      ----------
           Income (loss) from operations                 (2,378,000)      5,239,000                --     1,879,000       4,740,000
                                                      -------------      ----------     -------------    ----------      ----------
Other income (expense):
  Parent's share of subsidiaries net loss                 4,778,000              --                --    (4,778,000)             --
  Interest expense                                         (380,000)       (485,000)               --            --        (865,000)
  Other                                                     995,000         141,000                --    (1,879,000)       (743,000)
                                                      -------------      ----------     -------------    ----------      ----------
           Total other income (expense)                   5,393,000        (344,000)               --    (6,657,000)     (1,608,000)
                                                      -------------      ----------     -------------    ----------      ----------
           Income before income taxes                     3,015,000       4,895,000                --    (4,778,000)      3,132,000

Income tax benefit (expense)                                599,000        (117,000)               --            --         482,000
                                                      -------------      ----------     -------------    ----------      ----------
           Net income                                     3,614,000       4,778,000                --    (4,778,000)      3,614,000

Other comprehensive loss - adjustment for
  unrealized loss on investment                            (436,000)             --                --            --        (436,000)
                                                      -------------      ----------     -------------    ----------      ----------
           Comprehensive income                       $   3,178,000       4,778,000                --    (4,778,000)      3,178,000
                                                      =============      ==========     =============    ==========      ==========
</TABLE>

(d)  Consolidating  condensed  statement of operations  information for the year
ended May 31, 1999 is as follows:

<TABLE>
<CAPTION>
                                                                          Guarantor     Non-guarantor
                                                          Parent        subsidiaries    subsidiaries    Eliminations   Consolidated
                                                      --------------    ------------    -------------   ------------   ------------
<S>                                                   <C>               <C>             <C>             <C>            <C>
Net sales                                             $          --      56,675,000        52,814,000    (2,123,000)    107,366,000
Cost of sales                                                    --      46,150,000        42,275,000    (2,123,000)     86,302,000
                                                      -------------      ----------     -------------    ----------      ----------
           Gross profit                                          --      10,525,000        10,539,000            --      21,064,000

Operating expenses                                        4,367,000      16,194,000         3,556,000    (2,078,000)     22,039,000
                                                      -------------      ----------     -------------    ----------      ----------
           Income (loss) from operations                 (4,367,000)     (5,669,000)        6,983,000     2,078,000        (975,000)
                                                      -------------      ----------     -------------    ----------      ----------
Other income (expense):
  Parent's share of subsidiaries net loss                (1,800,000)             --                --     1,800,000              --
  Interest expense                                       (8,050,000)       (622,000)       (3,516,000)    3,516,000      (8,672,000)
  Other                                                    (727,000)        443,000            17,000    (5,594,000)     (5,861,000)
                                                      -------------      ----------     -------------    ----------      ----------
           Total other expense                          (10,577,000)       (179,000)       (3,499,000)     (278,000)    (14,533,000)
                                                      -------------      ----------     -------------    ----------      ----------
           Income (loss) before income taxes            (14,944,000)     (5,848,000)        3,484,000     1,800,000     (15,508,000)

Income tax benefit (expense)                              2,075,000       1,986,000        (1,422,000)           --       2,639,000
                                                      -------------      ----------     -------------    ----------      ----------
           Net income (loss)                            (12,869,000)     (3,862,000)        2,062,000     1,800,000     (12,869,000)
                                                      -------------      ----------     -------------    ----------      ----------
Other comprehensive income (loss):
  Foreign currency translation, net of tax                   (4,000)             --        (1,136,000)           --      (1,140,000)
  Adjustment for unrealized loss on investment              436,000              --                --            --         436,000
                                                      -------------      ----------     -------------    ----------      ----------
           Total other comprehensive income (loss)          432,000              --        (1,136,000)           --        (704,000)
                                                      -------------      ----------     -------------    ----------      ----------
           Comprehensive income (loss)                $ (12,437,000)     (3,862,000)          926,000     1,800,000     (13,573,000)
                                                      =============      ==========     =============    ==========     ===========
                                                                                                                         (Continued)
</TABLE>

                                       85
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


(e)  Consolidating condensed statement of operations information for the year
ended May 31, 2000 is as follows:

<TABLE>
<CAPTION>
                                                                           Guarantor   Non-guarantor
                                                            Parent       subsidiaries   subsidiaries     Eliminations   Consolidated
                                                         --------------  ------------  --------------   --------------  ------------
<S>                                                      <C>             <C>           <C>              <C>             <C>
Net sales                                                $         --      58,408,000      56,913,000      (2,627,000)  112,694,000
Cost of sales                                                      --      45,433,000      49,257,000      (2,627,000)   92,063,000
                                                         ------------    ------------  --------------   --------------  -----------

           Gross profit                                            --      12,975,000       7,656,000              --    20,631,000

Operating expenses                                          6,896,000      18,036,000       5,652,000      (6,051,000)   24,533,000
                                                         ------------    ------------  --------------   --------------  -----------

           Income (loss) from operations                   (6,896,000)     (5,061,000)      2,004,000       6,051,000    (3,902,000)
                                                         ------------    ------------  --------------   --------------  -----------
Other income (expense):
  Parent's share of subsidiaries net loss                  (7,738,000)             --              --       7,738,000            --
  Interest expense                                         (9,394,000)     (4,748,000)     (4,349,000)      8,532,000    (9,959,000)
  Other                                                    10,284,000       4,394,000          35,000     (14,583,000)      130,000
                                                         ------------    ------------  --------------   --------------  -----------

           Total other expense                             (6,848,000)       (354,000)     (4,314,000)      1,687,000    (9,829,000)
                                                         ------------    ------------  --------------   --------------  -----------
           Loss before income taxes and
              extraordinary item                          (13,744,000)     (5,415,000)     (2,310,000)      7,738,000   (13,731,000)

Income tax expense                                             (8,000)             --         (13,000)             --       (21,000)
Extraordinary item, net of tax                                703,000              --              --              --       703,000
                                                         ------------    ------------  --------------   --------------  -----------

           Net loss                                       (13,049,000)     (5,415,000)     (2,323,000)      7,738,000   (13,049,000)

Other comprehensive loss - foreign currency
  translation, net of tax                                  (5,110,000)             --      (5,110,000)      5,110,000    (5,110,000)
                                                         ------------    ------------  --------------   --------------  -----------

           Comprehensive loss                            $(18,159,000)     (5,415,000)     (7,433,000)     12,848,000   (18,159,000)
                                                         ============    ============  ==============   ==============  ===========
                                                                                                                         (Continued)
</TABLE>

                                       86
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000

(f)  Consolidating  condensed  statement of cash flows  information for the year
ended May 31, 1998 is as follows:

<TABLE>
<CAPTION>
                                                                             Guarantor    Non-guarantor
                                                                Parent      subsidiaries   subsidiaries   Eliminations  Consolidated
                                                             -------------  ------------  -------------   ------------  ------------
<S>                                                          <C>            <C>           <C>             <C>           <C>
Cash flow from operating activities - net cash provided
  by operating activities                                    $  4,023,000     2,349,000              --    (4,778,000)    1,594,000
                                                             ------------   -----------   -------------   -----------   -----------

Cash flow from investing activities:

  Acquisition of property, plant and equipment                 (3,010,000)   (3,499,000)             --            --    (6,509,000)
  Investment in and loans to subsidiaries                      (3,289,000)           --              --            --    (3,289,000)
  Other changes, net                                          (15,114,000)      125,000              --     8,082,000    (6,907,000)
                                                             ------------   -----------   -------------   -----------   -----------
          Net cash used in investing activities               (21,413,000)   (3,374,000)             --     8,082,000   (16,705,000)
                                                             ------------   -----------   -------------   -----------   -----------
Cash flow from financing activities:

  Payments on long-term debt and capital leases                  (125,000)   (1,378,000)             --            --    (1,503,000)
  Proceeds from long-term debt                                  9,590,000       535,000              --            --    10,125,000
  Proceeds from sale of common stock, net                       2,223,000            --              --            --     2,223,000
  Proceeds from sale of preferred stock, net                    9,260,000            --              --            --     9,260,000
  Other changes, net                                            3,777,000     2,946,000              --    (3,304,000)    3,419,000
                                                             ------------   -----------   -------------   -----------   -----------
          Net cash provided by financing activities            24,725,000     2,103,000              --    (3,304,000)   23,524,000
                                                             ------------   -----------   -------------   -----------   -----------

          Net change in cash and cash equivalents               7,335,000     1,078,000              --            --     8,413,000

Cash and cash equivalents at beginning of year                  2,063,000       985,000              --            --     3,048,000
                                                             ------------   -----------   -------------   -----------   -----------
Cash and cash equivalents at end of year                     $  9,398,000     2,063,000              --            --    11,461,000
                                                             ============   ===========   =============   ===========   ===========
Supplemental cash flow:
  Noncash operating expenses related to:
    Depreciation                                             $     34,000     1,874,000              --            --     1,908,000
    Amortization                                                       --       296,000              --            --       296,000
  Cash paid during the year for:

    Interest                                                       17,000       695,000              --            --       712,000
    Income taxes                                                  521,000            --              --            --       521,000
  Acquisition of subsidiaries:
    Fair value of assets acquired and resulting
      goodwill, excluding cash                                 10,034,000            --              --            --    10,034,000
    Liabilities assumed                                         3,925,000            --              --            --     3,925,000
    Common stock issued                                         6,109,000            --              --            --     6,109,000
  Noncash investing and financing activities:
    Seller financed acquisition of property,
      plant and equipment                                              --     3,336,000              --            --     3,336,000
    Conversion of notes and accrued interest
      to common stock                                           5,519,000            --              --            --     5,519,000
    Restructuring of certain notes receivable
      for an investment in common stock                         6,053,000            --              --            --     6,053,000
    Other noncash investing and financing
      activities, net                                             750,000       139,000              --            --       889,000
                                                                                                                        (Continued)
</TABLE>

                                       87
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000


(g) Consolidating condensed statement of cash flows information for the year
ended May 31, 1999 is as follows:

<TABLE>
<CAPTION>
                                                                         Guarantor     Non-guarantor
                                                             Parent     subsidiaries   subsidiaries    Eliminations  Consolidated
                                                         ------------   ------------   ------------    ------------  ------------
<S>                                                     <C>            <C>             <C>            <C>           <C>

Cash flow from operating activities - net cash
  provided by (used in) operating activities             $ (7,015,000)      888,000      3,955,000      1,800,000      (372,000)
                                                         ------------   ------------   ------------     -----------  -------------

Cash flow from investing activities:
  Acquisition of property, plant and equipment             (2,251,000)   (4,206,000)    (1,583,000)           --     (8,040,000)
  Investment in and loans to subsidiaries                 (69,752,000)  (72,618,000)           --      72,618,000   (69,752,000)
  Other changes, net                                       (6,401,000)       76,000        (85,000)     4,928,000    (1,482,000)
                                                         ------------   -----------     ----------     ----------   -----------
             Net cash used in investing activities        (78,404,000)  (76,748,000)    (1,668,000)    77,546,000   (79,274,000)
                                                         ------------   -----------     ----------     ----------   -----------

Cash flow from financing activities:
  Payments on long-term debt and capital leases            (4,154,000)   (1,548,000)       (50,000)           --     (5,752,000)
  Proceeds from long-term debt                             72,160,000    72,618,000            --     (72,618,000)   72,160,000
  Proceeds from sale of common stock, net                   4,898,000           --             --             --      4,898,000
  Proceeds from sale of preferred stock, net                6,630,000           --             --             --      6,630,000
  Other changes, net                                       (1,715,000)    2,765,000      4,167,000     (6,728,000)   (1,511,000)
                                                         ------------    ----------      ---------     ----------    ----------
             Net cash provided by financing activities     77,819,000    73,835,000      4,117,000    (79,346,000)   76,425,000
                                                         ------------    ----------      ---------     ----------    ----------
             Net change in cash and cash equivalents       (7,600,000)   (2,025,000)     6,404,000            --     (3,221,000)

Cash and cash equivalents at beginning of year              9,398,000     2,063,000            --             --     11,461,000

Effect of exchange rates on cash                                  --            --        (106,000)           --       (106,000)
                                                         ------------    ----------      ---------     ----------     ---------
Cash and cash equivalents at end of year                 $  1,798,000        38,000      6,298,000            --      8,134,000
                                                         ============    ==========      =========     ==========     =========

Supplemental cash flow:
  Noncash operating expenses related to:
    Depreciation                                         $    192,000     2,970,000      2,306,000            --      5,468,000
    Amortization                                                  --        392,000        844,000            --      1,236,000
  Cash paid during the year for:
    Interest                                                4,870,000       413,000         13,000            --      5,296,000
    Income taxes                                              100,000           --         311,000            --        411,000
  Noncash investing and financing activities:
    Seller financed acquisition of property, plant
      and equipment                                               --        241,000            --             --        241,000
    Reclassification of property, plant and
      equipment to other assets                                   --      1,217,000            --             --      1,217,000
                                                                                                                    (Continued)
</TABLE>

                                       88
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 1999 and 2000

(h)  Consolidating condensed statement of cash flows information for the year
ended May 31, 2000 is as follows:

<TABLE>
<CAPTION>
                                                                       Guarantor     Non-guarantor
                                                       Parent        subsidiaries    subsidiaries     Eliminations    Consolidated
                                                    ------------    -------------   -------------   --------------   --------------
<S>                                                 <C>             <C>             <C>             <C>               <C>
Cash flow from operating activities - net cash
  provided by (used in) operating activities        $ (11,649,000)      1,510,000      (2,806,000)      7,738,000       (5,207,000)
                                                     ------------    ------------    ------------    ------------     ------------
Cash flow from investing activities:
  Acquisition of property, plant and equipment           (767,000)     (2,846,000)     (1,254,000)             --       (4,867,000)
  Investment in and loans to subsidiaries              (1,282,000)        (39,000)             --              --       (1,321,000)
  Other changes, net                                    2,234,000          21,000          85,000      (3,825,000)      (1,485,000)
                                                     ------------    ------------    ------------    ------------     ------------
            Net cash provided by (used in)
              investing activities                        185,000      (2,864,000)     (1,169,000)     (3,825,000)      (7,673,000)
                                                     ------------    ------------    ------------    ------------     ------------
Cash flow from financing activities:
  Net borrowings (repayments) under line of credit      5,379,000        (161,000)             --              --        5,218,000
  Payments on long-term debt and capital leases          (116,000)     (2,328,000)       (159,000)             --       (2,603,000)
  Proceeds from sale of common stock, net               4,169,000              --              --              --        4,169,000
  Other changes, net                                       50,000       3,863,000          50,000      (3,913,000)          50,000
                                                     ------------    ------------    ------------    ------------     ------------

            Net cash provided by (used in)
              financing activities                      9,482,000       1,374,000        (109,000)     (3,913,000)       6,834,000
                                                     ------------    ------------    ------------    ------------     ------------
            Net change in cash and cash equivalents    (1,982,000)         20,000      (4,084,000)             --       (6,046,000)

Cash and cash equivalents at beginning of year          1,798,000          38,000       6,298,000              --        8,134,000

Effect of exchange rates on cash                               --              --          66,000              --           66,000
                                                     ------------    ------------    ------------    ------------     ------------
Cash and cash equivalents at end of year            $    (184,000)         58,000       2,280,000              --        2,154,000
                                                     ============    ============    ============    ============     ============

Supplemental cash flow:
  Noncash operating expenses related to:
    Depreciation                                    $     436,000       3,018,000       2,721,000              --        6,175,000
    Amortization                                               --         475,000         981,000              --        1,456,000
    Impairment of long-lived assets                       178,000       5,097,000              --              --        5,275,000
  Cash paid during the year for:
    Interest                                            8,997,000       3,719,000       7,900,000     (11,053,000)       9,563,000
    Income taxes                                               --              --       2,232,000              --        2,232,000
  Noncash investing and financing activities -
    conversion of notes and accrued interest to        11,457,000              --              --              --       11,457,000
       common stock
                                                                                                                       (Continued)
</TABLE>

                                      89
<PAGE>

     (i)  Inventory information at May 31 is as follows:

<TABLE>
<CAPTION>
                                                      1999             2000
                                                 -------------   -------------
          <S>                                    <C>             <C>
          Guarantor subsidiaries
           Raw materials                         $   5,074,000       5,492,000
           Work in progress                          3,788,000       5,439,000
           Finished goods                            4,702,000       6,376,000
                                                 -------------   -------------
                                                    13,564,000      17,307,000
                                                 -------------   -------------
          Non-guarantor subsidiaries:
           Raw materials                             2,300,000       1,712,000
           Work in progress                          7,690,000       8,142,000
           Finished goods                            1,062,000         688,000
                                                 -------------   -------------
                                                    11,052,000      10,542,000
                                                 -------------   -------------
                 Total inventories               $  24,616,000      27,849,000
                                                 =============   =============
</TABLE>

(23) Subsequent Event

     Subsequent to the end of fiscal year 2000, in July, 2000, the Company
     closed the first installment of a $3.5 million private placement of common
     stock to two accredited investors. On that date, the Company issued
     1,142,860 shares of common stock and warrants to purchase additional shares
     to the investors for a gross amount of $2.0 million. The Company expects to
     file a registration statement on Form S-3 with the Securities and Exchange
     Commission to register the resale of the shares of common stock issued or
     issuable as a result of the transaction (the "Registration Statement").
     Upon effectiveness of the Registration Statement within sixty days after
     the first closing, a second closing will occur, and the investors will pay
     an additional $1.5 million and receive 857,140 additional shares of common
     stock. The effectiveness of the Registration Statement within 60 days after
     the first closing is the only condition to the second closing.

                                       90

<PAGE>

ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
          FINANCIAL DISCLOSURE

None.

                                       91
<PAGE>

                                   PART III


ITEM 10.    DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

Directors and Executive Officers

The following table sets forth information as of August 18, 2000, regarding the
current directors and those nominated to become directors, and the executive
officers of the Company.

<TABLE>
<CAPTION>
Name                     Age                    Position with Company
---------------------------------------------------------------------------
<S>                     <C>        <C>
Donald A. Wright               48  Chairman of the Board, Chief Executive
                                   Officer And President

Werner Hafelfinger             54  Chief Operating Officer, Vice President
                                   Operations, Director

Nick A. Gerde                  55  Chief Financial Officer, Vice President
                                   Finance, Treasurer and Assistant Secretary

Sheryl A. Symonds              45  Vice President Administration, General
                                   Counsel And Secretary

Allen W. Dahl, M.D.            72  Director*

Dale L. Rasmussen              50  Director

Gene C. Sharratt, Ph.D.        53  Director Nominee**

Robert M. Stemmler             65  Director

William A. Wheeler             66  Director
</TABLE>

_____________

* Dr. Dahl retired as a director at the October 10, 2000 annual shareholders
meeting.
** Dr. Sharratt was elected as director at the October 10, 2000 annual
shareholders meeting.

Donald A. Wright. Donald A. Wright has been the Chairman of the Board, Chief
Executive Officer and President of the Company since February 1995, and of its
predecessors since 1990. Mr. Wright is also an officer and director of each of
the Company's operating subsidiaries.

Werner Hafelfinger. Werner Hafelfinger has been a director of the Company since
August 17, 1998. Mr. Hafelfinger has been Vice President Operations and Chief
Operating Officer of the Company since March 1999. Mr. Hafelfinger was employed
by St. Jude Medical (Cardiac Rhythm Management Division), a manufacturer of
implantable medical devices, from 1984 until February 1999, where he served as
Vice President of Global Manufacturing.

                                       92
<PAGE>

Nick A. Gerde. Nick A. Gerde has been the Vice President Finance and Chief
Financial Officer of the Company since February 1995. He has been the Treasurer
of the Company since August 1996, and Assistant Secretary since November 1996.
Mr. Gerde is also an officer and director of each of the Company's operating
subsidiaries. Mr. Gerde served as a Business Development Specialist with the
Economic Development Council of North Central Washington from July 1993 to June
1994, and as Vice President of Televar Northwest, Inc. (formerly a subsidiary of
Orca Technologies, Inc.) from July 1994 to February 1995.

Sheryl A. Symonds. Sheryl A. Symonds has been the Vice President Administration
and General Counsel of the Company since September 1997. Prior to joining the
Company, Ms. Symonds was a partner at Stoel Rives LLP, currently the Company's
primary outside legal counsel. Ms. Symonds joined Stoel Rives LLP in 1985 and
became a partner in 1992. Ms. Symonds has been Secretary of the Company since
August 1996 and is also Secretary of each of the Company's operating
subsidiaries.

Allen W. Dahl. Dr. Allen W. Dahl has been a director of the Company since
February 1995, and of its predecessors since September 1994. Dr. Dahl is retired
from practice as a physician in the Puget Sound region of Washington. Dr. Dahl
has announced his retirement from the Board of Directors as of the annual
meeting of shareholders on October 10, 2000.

Dale L. Rasmussen. Dale L. Rasmussen has been a director of the Company since
June 1997. Mr. Rasmussen has been employed as the Senior Vice President and
Secretary of IMPCO Technologies, Inc. since 1989.

Gene C. Sharratt. Dr. Gene C. Sharratt has been nominated to become a director
of the Company and was elected at the annual meeting of shareholders on October
10, 2000. Dr. Sharratt has been Superintendent of the North Central Education
Service District in Wenatchee, Washington since July 1991.

Robert M. Stemmler. Robert M. Stemmler has been a director of the Company since
May 14, 1999. Mr. Stemmler has been the Chairman, CEO and President of IMPCO
Technologies, Inc. since 1993.

William A. Wheeler. William A. Wheeler has been a director of the Company since
June 1997. Mr. Wheeler retired from Dowty Aerospace Yakima in May 1997, where he
served as President, Chief Executive Officer and Chairman of the Board of
Directors since 1979.

Other Significant Employees

Lewis L. Wear. Lewis L. Wear, 59, has been President of the U.S. Electronics
Group since August 1996 and President of Pacific Coast Technologies, Inc. since
February 1996. He also has been Vice President of Ceramic Devices since October
1997, President of NTI since April 1997, President of Balo since February 1998,
and President of ESC since October 1998. Prior to November 1995, Mr. Wear was
Vice President of Operations for Vacuum Atmospheres, a division of WEMS, Inc.

Duncan Crighton. Duncan Crighton, 64, has been Chief Executive Officer of
Aeromet since March 1997 and became President of the Company's European
Aerospace Group upon closing of the Aeromet Acquisition. Mr. Crighton served as
Managing Director of Aeromet's predecessor, Kent Aerospace Castings plc, from
1990 through 1995, and as a management consultant to Aeromet from 1995 to
February 1997.

                                       93
<PAGE>

Board of Directors

Committees.  The Board of Directors has a number of committees, as follows:

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------
                                                                                                      Members as of
      Committee                             Function                                                  August 18, 2000
      ---------                             --------                                                  ---------------
------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>                                                       <C>
      Option Committee                      Administers the Company's Amended and Restated Stock       Dr. Dahl
                                            Incentive Plan and 1999 Stock Incentive Plan.              Mr. Rasmussen
                                                                                                       Mr. Stemmler
------------------------------------------------------------------------------------------------------------------------
      Finance and Audit Committee           Reviews the Company's accounting policies, practices,      Mr. Rasmussen
                                            internal accounting controls and financial reporting.      Mr. Stemmler
                                            Also oversees engagement of the Company's independent      Mr. Wheeler
                                            auditors and monitors management implementation of
                                            the recommendations and findings of the Company's
                                            independent auditors.
------------------------------------------------------------------------------------------------------------------------
      Compensation Committee                Establishes salaries, incentives and other                 Mr. Wheeler
                                            compensation for the chief executive officer, chief        Dr. Dahl
                                            operating officer, chief financial officer, general        Mr. Rasmussen
                                            counsel, subsidiary presidents and other key
                                            employees of the Company and its subsidiaries. Also
                                            administers policies relating to compensation and
                                            benefits, including the Amended and Restated
                                            Independent Director Stock Plan and the Employee
                                            Stock Purchase Plan.
------------------------------------------------------------------------------------------------------------------------
      Nominating Committee                  Recommends individuals to be presented to the              Mr. Wright
                                            shareholders for election or reelection to the Board       Mr. Rasmussen
                                            of Directors.                                              Mr. Stemmler
------------------------------------------------------------------------------------------------------------------------
</TABLE>

Tenure. Directors of the Company hold office until the next annual meeting of
the Company's shareholders and until their successors have been elected and duly
qualified. The Board of Directors appoints the Company's executive officers at
the first Board meeting after each annual meeting of shareholders. Executive
officers hold office at the pleasure of the Board of Directors.

Compensation. Under the Company's Amended and Restated Independent Director
Stock Plan, each non-employee director of the Company receives an initial award
of options to purchase 2,500 shares of Common Stock when that director is first
elected and an annual award of options to purchase 10,000 shares of Common
Stock. In addition, non-employee directors receive $1,000 in cash per year for
each committee on which they serve, and an additional $500 in cash per year for
serving as chairperson of a committee. The Board may elect to pay any of the
cash fees in shares of Common Stock. See "Executive Compensation - Benefit
Plans -Independent Director Stock Plan." All directors are reimbursed for
reasonable travel and other out-of-pocket expenses incurred in attending
meetings of the Board of Directors.

                                       94
<PAGE>

Section 16(a) Beneficial Ownership Reporting Compliance

     Based solely on a review of Forms 3, 4 and 5 and any amendments thereto
furnished to the Company pursuant to Rule 16a-3(e) during its most recent fiscal
year, and on written representations of the Company's officers, directors, or
principal shareholders ("Reporting Persons") that no other reports were
required, the Company believes that, during the fiscal year ended May 31, 2000,
the Reporting Persons complied in all material respects with all applicable
filing requirements under Section 16(a) of the Exchange Act.

                                       95
<PAGE>

ITEM 11.     EXECUTIVE COMPENSATION

Summary Compensation Table

The following table sets forth in summary form the compensation paid by the
Company to the Chief Executive Officer and to the Company's three most highly
compensated executive officers (the "Named Executives") for services in all
capacities to the Company for the last three fiscal years:

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
                                                   Annual             Long-Term
                                                 Compensation        Compensation
------------------------------------------------------------------------------------------------------------------
                                                                      Securities                   Other Annual
Name and Principal              Fiscal                                 Underlying                  Compensation
Position                         Year             Salary ($)        Options/SARs(#)/(1)/           ($)
------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------
<S>                             <C>                <C>              <C>                            <C>
Donald A. Wright                  2000             292,008                450,000/(2)/               5,800/(4)/
                               -----------------------------------------------------------------------------------
CEO and President                 1999             247,551              1,000,000/(3)/               5,547/(4)/
                               -----------------------------------------------------------------------------------
                                  1998             192,000                650,000/(5)/               4,800/(6)/
------------------------------------------------------------------------------------------------------------------
Werner Hafelfinger                2000             175,000                100,000/(2)/               2,500/(6)/
                               -----------------------------------------------------------------------------------
COO, VP Operations                1999/(7)/         33,654                 60,000/(8)/                 600/(6)/
------------------------------------------------------------------------------------------------------------------
Nick A. Gerde                     2000             140,000                100,000/(2)/               2,500/(6)/
                               -----------------------------------------------------------------------------------
CFO, VP Finance,                  1999             130,000                116,056/(3)/               2,400/(6)/
                               -----------------------------------------------------------------------------------
Treasurer and                     1998             100,000                 75,000/(5)/               2,400/(6)/
                               -----------------------------------------------------------------------------------
Assistant Secretary
------------------------------------------------------------------------------------------------------------------
Sheryl A. Symonds                 2000             176,364                100,000/(2)/                 --
                               -----------------------------------------------------------------------------------
VP Administration,                1999             160,973                160,000/(3)/                 --
                               -----------------------------------------------------------------------------------
General Counsel and               1998/(9)/        105,000                160,000/(5)/                 --
                               -----------------------------------------------------------------------------------
Secretary
------------------------------------------------------------------------------------------------------------------
</TABLE>
________________________
/(1)/  Represents options to purchase shares of Common Stock.

/(2)/  One-half of these options were granted in June 1999 with respect to
       fiscal 1999, and one-half were granted in May 2000, with respect to
       fiscal 2000.

/(3)/  Represents repricing of previously granted options. On December 4, 1998,
       the Board of Directors approved the repricing of outstanding options
       under the Company's Amended and Restated Stock Incentive Plan. For
       purposes of this table, repriced options are considered to be option
       grants and, therefore, are required to be included in the table as
       options granted in fiscal 1999. Other than repricing of options, no
       options were granted to Mr. Wright, Mr. Gerde, or Ms. Symonds during
       fiscal 1999.

/(4)/  Represents estimated value of the personal use of Company vehicles
       ($5,000 in fiscal 2000; $4,800 in fiscal 1999) and premiums on $2 million
       of key-man life insurance denoting Mr. Wright's spouse as beneficiary.

/(5)/  These options were repriced in fiscal 1999, and the entire balance is
       also included in this table as options granted during fiscal 1999. See
       footnote (3) above.

/(6)/  Represents estimated value of the personal use of a Company vehicle.

/(7)/  Represents the compensation received by Mr. Hafelfinger during the three
       months he was employed by the Company in fiscal year 1999.

/(8)/  Includes options to purchase 10,000 shares granted to Mr. Hafelfinger in
       October 1998 under the Amended and Restated Independent Director Stock
       Plan, when Mr. Hafelfinger was a non-employee director of the Company.

/(9)/  Represents the compensation received by Ms. Symonds during the nine
       months she was employed by the Company in fiscal year 1998.

                                       96
<PAGE>

Option Grants Table

The following table sets forth information on grants of stock options by the
Company during the year ended May 31, 2000 to the Named Executives:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
                            Securities       % of Total
                            Underlying     Options Granted     Exercise or                        Grant Date
                              Options      to Employees in     Base Price      Expiration     Present Value/(1)/
Name                        Granted (#)      Fiscal Year        ($/Share)         Date               ($)
-----------------------------------------------------------------------------------------------------------------
<S>                         <C>            <C>                 <C>             <C>            <C>
-----------------------------------------------------------------------------------------------------------------
Donald A. Wright              225,000            24.73%          $1.6875          5/31/09          $309,000
-----------------------------------------------------------------------------------------------------------------
                              225,000            24.73%          $1.5000          5/04/10          $324,000
-----------------------------------------------------------------------------------------------------------------

-----------------------------------------------------------------------------------------------------------------
Werner Hafelfinger             50,000             5.49%          $1.6875          5/31/09          $ 69,000
-----------------------------------------------------------------------------------------------------------------
                               50,000             5.49%          $1.5000          5/04/10          $ 72,000
-----------------------------------------------------------------------------------------------------------------

-----------------------------------------------------------------------------------------------------------------
Nick A. Gerde                  50,000             5.49%          $1.6875          5/31/09          $ 69,000
-----------------------------------------------------------------------------------------------------------------
                               50,000             5.49%          $1.5000          5/04/10          $ 72,000
-----------------------------------------------------------------------------------------------------------------

-----------------------------------------------------------------------------------------------------------------
Sheryl A. Symonds              50,000             5.49%          $1.6875          5/31/09          $ 69,000
-----------------------------------------------------------------------------------------------------------------
                               50,000             5.49%          $1.5000          5/04/10          $ 72,000
-----------------------------------------------------------------------------------------------------------------
</TABLE>

_____________
(1)  Although the Company believes that it is not possible to place a value on
     an option, in accordance with the rules of the SEC, the Company has used a
     Black-Scholes model of option valuation to estimate grant date present
     value.  The actual value realized, if any, may vary significantly from the
     values estimated by this model.  Any future values realized will ultimately
     depend upon the excess of the stock price over the exercise price on the
     date the option is exercised.  The assumptions used to estimate the grant
     date present value of this option were:  volatility (71.86% and 121.75%);
     risk-free rate of return (6%); dividend yield (0%); and time of exercise
     (remaining life 10 years).

                                       97
<PAGE>

Aggregated Options and Fiscal Year-End Option Values

The following table summarizes the aggregate employee stock options and non-
public warrants, and their market values at May 31, 2000, held by the Named
Executives:

<TABLE>
<CAPTION>
                                               Number of Securities               Value of Unexercised
                                              Underlying Unexercised              In-the-Money Options
                                               Options at FY-end (#)               at FY-end ($)/(1)/
                                        ---------------------------------------------------------------------
Name                                      Exercisable      Unexercisable     Exercisable      Unexercisable
----                                      -----------      -------------     -----------      -------------
<S>                                     <C>              <C>                <C>             <C>
Donald A. Wright                           2,232,560              --              --                 --
Werner Hafelfinger/(2)/                      160,000              --              --                 --
Nick A. Gerde                                266,178           4,878              --                 --
Sheryl A. Symonds                            260,000              --              --                 --
</TABLE>

(1)  No options or warrants held by the Named Executives had exercise prices of
     less than $1.25 per share, the closing price of the Common Stock on May 31,
     2000.

(2)  Includes options to purchase 10,000 shares granted to Mr. Hafelfinger in
     October 1998 under the Amended and Restated Independent Director Stock
     Plan, when Mr. Hafelfinger was a non-employee director of the Company.

Employment Agreements

The Company has entered into employment agreements with each of the Named
Executives.  The employment agreements employ Mr. Wright through fiscal 2003,
and employ Mr. Hafelfinger, Mr. Gerde, and Ms. Symonds through fiscal 2002.  The
employment agreements provide for an annual salary in fiscal 2001 of $335,809,
$200,000, $150,000 and $190,473, for Mr. Wright, Mr. Hafelfinger, Mr. Gerde, and
Ms. Symonds, respectively.  The employment agreements also provide for the
annual grant to each of the Named Executives of options to purchase up to
275,000 shares of Common Stock for Mr. Wright, and up to 50,000 shares of Common
Stock for Mr. Hafelfinger, Mr. Gerde, and Ms. Symonds.  Of these, 50,000 of Mr.
Wright's options are fixed, 25,000 of the other Named Executive's options are
fixed, and the remainder are discretionary.  The exercise price of any such
options is equal to the fair market value of the Common Stock on the date of
grant.  Each option may contain vesting and other terms as are approved by the
Board of Directors, and will expire ten years after the date of grant.  If a
Named Executive's employment with the Company is terminated without cause, or if
there is a change of control, as those terms are defined in their employment
agreements, the Company will be required to make severance payments equal to, in
the case of Mr. Wright, twice Mr. Wright's then-current annual base salary; in
the case of Mr. Gerde, one times his then-current annual base salary; in the
case of Ms. Symonds, one and one-half times her then-current annual base salary;
and in the case of Mr. Hafelfinger, twice his then-current annual base salary in
the event of a change in control or one times his then-current annual base
salary if he is terminated without cause.  Under these employment agreements,
Mr. Wright, Mr. Hafelfinger, and Mr. Gerde agree not to compete with the Company
for two years following termination of employment.  In May 1999, the Board of
Directors adopted a management incentive compensation program, which provides
for the payment of cash bonuses to the Named Executives, the group presidents,
and certain other senior managers, upon attainment of certain goals.  Under this
program, each of the Named Executives could have earned a cash bonus for fiscal
2000 of 10% of his or her annual salary if the Company achieved budgeted
operating income levels for the year and an additional 5% if the Company
exceeded budgeted operating income by 10%.  In addition, each of the Named
Executives could have earned a cash bonus of up to 5% of his or her annual
salary upon achieving personal goals and objectives for a possible total

                                       98
<PAGE>

bonus of 20% of annual salary. The Named Executives did not earn any bonus under
this program for fiscal 2000 because the Company did not earn a profit. In
August 2000, the Board of Directors amended the management incentive
compensation program for fiscal 2001. Under the amended program, each of the
Named Executives can earn a cash bonus of 10% of his or her annual salary if the
Company achieves both budgeted revenue and budgeted operating income levels for
the year and an additional 5% if the Company exceeds these budgeted amounts by
10%, for a possible total bonus of 15% of annual salary.

Certain Tax Considerations Related to Executive Compensation

As a result of Section 162(m) of the Code, if the Company pays more that
$1,000,000 in compensation to a "covered employee" (the chief executive officer
and the next four highest paid employees) in a single year, then the Company's
deduction for such compensation could be limited to $1,000,000.

Benefit Plans

1999 Stock Incentive Plan

The Company's shareholders adopted the Company's 1999 Stock Incentive Plan (the
"1999 Plan") in October 1999.  The Company has reserved for issuance under the
1999 Plan a maximum of 4,000,000 shares of Common Stock, subject to certain
adjustments.  Under the 1999 Plan, the plan administrator may award incentive
stock options ("ISOs") to key employees, and may award non-qualified stock
options ("NSOs"), stock appreciation rights ("SARs"), stock and cash bonus
awards, restricted stock, and performance units to employees and certain non-
employees (other than non-employee directors) who have important relationships
with the Company or its subsidiaries.  However, no person may receive options to
purchase more than 1,000,000 shares in any one year.  As of May 31, 2000,
options to purchase an aggregate of 430,000 shares of Common Stock had been
granted under the 1999 Plan, leaving 3,570,000 shares available as of May 31,
2000 for future grant under the 1999 Plan.  No SARs, stock or cash bonus awards,
restricted stock, or performance units have been granted under the 1999 Plan.

The 1999 Plan is administered by the Option Committee of the Board of Directors,
which is comprised of disinterested directors in accordance with Rule 16b-3
under the Exchange Act, and of outside directors under Section 162(m) of the
Internal Revenue Code.  However, only the Board of Directors may amend or
terminate the 1999 Plan.  Unless terminated sooner by the Board of Directors,
the 1999 Plan expires in July 2009.  The 1999 Plan provides that, in general, a
vested option would have to be exercised within three months after the
optionee's employment or service with the Company or a subsidiary terminates.
However, options would be exercisable within 24 months following termination of
employment because of retirement, disability, or death, and options would
terminate automatically if an optionee were terminated for cause.  Options,
SARs, cash and stock bonus awards and performance units are nonassignable and
nontransferable except by will or by the laws of descent and distribution at the
time of the recipient's death.  On the date an ISO is granted, the aggregate
fair market value of the Common Stock issuable under ISOs available for exercise
during any calendar year, may not exceed $100,000.  ISOs must expire ten years
from the date of grant, and the exercise price must equal the fair market value
of the underlying shares of Common Stock at the date of grant.  ISOs may not be
granted to employees holding more than 10% of the Company's total voting power
unless (a) the exercise price is at least 110% of the Common Stock's fair market
value on the date of grant, and (b) the option is not exercisable until five
years after the date of grant.

                                       99
<PAGE>

Amended and Restated Stock Incentive Plan

The Company's shareholders adopted the Company's Amended and Restated Stock
Incentive Plan (the "1996 Plan") in October 1996.  The Company has reserved for
issuance under the 1996 Plan a maximum of 3,000,000 shares of Common Stock,
subject to certain adjustments.  As of May 31, 2000, options to purchase an
aggregate of 3,144,448 shares of Common Stock had been granted under the 1996
Plan, of which options for 25,000 shares had been exercised, and options for
195,500 shares had been forfeited, leaving 51,052 shares available as of May 31,
2000 for future grants under the 1996 Plan.  The terms and administration of the
1996 Plan are substantially similar to those of the 1999 Plan.  The primary
differences between the 1999 Plan and the 1996 Plan relate to the termination
provisions for options.  Under the 1996 Plan, options would expire 12 months
after the termination of employment by reason of death or disability or within
three months after termination for any other reason except for cause.

Independent Director Stock Plan

The Company's shareholders adopted the Company's original Independent Director
Stock Plan in November 1995.  Following approval by the shareholders at the
Company's 1998 Annual Meeting, the plan was amended and restated.  The Company
has reserved for issuance under the Amended and Restated Independent Director
Stock Plan (the "Director Plan") a maximum of 500,000 shares of Common Stock,
subject to adjustments, issuable to directors who are not employees of the
Company or any of its subsidiaries.

The Director Plan is administered by the Compensation Committee of the Board of
Directors in accordance with Rule 16b-3 adopted under the Exchange Act.  No
director may vote on any matter relating to an award held by such director.
Only the Board of Directors may suspend, amend or terminate the Director Plan.
Unless terminated sooner by the Board of Directors, the Director Plan expires on
October 2005.

Under the Director Plan, as amended in 1998, each Independent Director receives
fully-vested, non-qualified options to purchase up to 2,500 shares of Common
Stock upon election to the Board (the "Initial Award").  Each time an
Independent Director is elected to the Board (or on the date of each annual
shareholders' meeting during terms longer than one year), each Independent
Director receives an option to purchase up to 10,000 shares of Common Stock (the
"Annual Award").  Annual Awards vest in full on the first anniversary of grant
(the "Vesting Period") if the Independent Director has attended at least 75% of
the regularly scheduled Board meetings during the Vesting Period.  Otherwise the
Annual Award is forfeited, unless the Board of Directors votes unanimously to
waive or modify the vesting requirement.  An unvested Annual Award will also be
forfeited if the director ceases to be an Independent Director during the
Vesting Period for any reason other than death or disability unless the Board
votes unanimously to waive that requirement.  However, unvested Annual Awards
automatically vest (a) if the director is unable to continue due to disability
or death, (b) upon the closing of any merger, consolidation or plan of exchange
in which the Company does not survive, or (c) upon sale of all or substantially
all of the Company's assets.  The exercise price of options granted under the
Director Plan is based on the fair market value of the Company's Common Stock
for the five trading days prior to the date of determination.  No Independent
Director may transfer any interest in unvested Annual Awards to any person other
than to the Company.

                                      100
<PAGE>

At May 31, 2000, 32,559 shares of Common Stock had been issued under the
Director Plan, and options to purchase an additional 96,637 shares of Common
Stock had been granted, 10,000 of which were forfeited, leaving 380,804 shares
available for issuance under the Director Plan.

Employee Stock Purchase Plan

The Company's shareholders adopted the Company's 1997 Employee Stock Purchase
Plan in October 1997 (the "Employee Stock Plan").  The Company has reserved for
issuance under the Employee Stock Plan a maximum of 1,000,000 shares of Common
Stock, subject to certain adjustments, for issuance to eligible employees of the
Company and its subsidiaries.  The Company pays all expenses relating to the
Employee Stock Plan except expenses related to the resale of shares acquired by
employees under the plan.  The Employee Stock Plan is administered by the
Compensation Committee of the Board of Directors.  The plan administrator has
designated Salomon Smith Barney, Inc. as the plan's custodian to vote the shares
pursuant to the participants' instructions, keep the plan records, and provide
periodic statements to participants.  Under the Employee Stock Plan, eligible
employees may purchase shares of the Company's Common Stock through payroll
deductions ranging from a minimum of $20 bi-weekly, to a maximum of 15% of the
employee's annual gross pay or $25,000.  The purchase price per share is the
lower of (a) 85% of fair market value on the first day of the offering period,
or (b) 100% of fair market value on the last day of the offering period.  The
first offering period began November 1, 1998, and offering periods are one month
long.  Plan participants may sell their shares through the plan custodian for a
discounted brokerage fee.  If a participant's employment terminates before the
end of any offering period, no shares are purchased for the participant during
that period and the payroll deduction is returned to the participant.  Between
June 1, 1999 and May 31, 2000, between 107 and 171 employees participated in the
Employee Stock Plan each month, purchasing stock at prices ranging between
$0.7969 per share and $2.3750 per share.  During fiscal 2000, a total of 142,696
shares of Common Stock were issued under the Employee Stock Plan, and a total of
209,698 shares have been issued since inception of the plan.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Principal Shareholders

The following table shows, to the best of the Company's knowledge based on the
records of the Company's transfer agent and the Company's records on issuances
of shares, as adjusted to reflect changes in ownership documented in filings
with the Securities and Exchange Commission made by certain shareholders and
provided to the Company pursuant to Section 16 of the Exchange Act, and
statements provided to the Company by certain shareholders, the Common Stock
owned as of August 18, 2000, by (1) each person known by the Company to own
beneficially more than 5% of the outstanding Common Stock; (2) each of the
Company's current directors and those nominated to become directors; (3) the
Named Executives; and (4) all executive officers and current directors of the
Company as a group.  Except as otherwise noted, the Company believes the persons
listed below have sole investment and voting power with respect to the Common
Stock owned by them.

                                      101
<PAGE>

<TABLE>
<CAPTION>
                                                                      Amount and Nature of            Percentage of
Name and Address of Beneficial Owner:                              Beneficial Ownership /(1)/         Common Stock
-------------------------------------                              --------------------------         ------------
<S>                                                                <C>                                <C>
Donald A. Wright /(2)/                                                     2,655,710                      7.19%
c/o Pacific Aerospace & Electronics, Inc.
430 Olds Station Road, Third Floor
Wenatchee, WA 98801

Allen W. Dahl, M.D. /(3)/                                                     42,401                         *
7300 Madrona Drive NE
Bainbridge Island, WA 98110

Werner Hafelfinger /(4)/                                                     289,048                         *
c/o Pacific Aerospace & Electronics, Inc.
430 Olds Station Road, Third Floor
Wenatchee, WA 98801

Dale L. Rasmussen /(3)/                                                       20,492                         *
c/o IMPCO Technologies, Inc.
708 Industrial Drive
Tukwila, WA 98188

Gene C. Sharratt, Ph.D. /(5)/                                                     --                         *
c/o North Central Educational Service District
P.O. Box 1847
Wenatchee, WA 98807

Robert M. Stemmler /(6)/                                                       8,137                         *
c/o IMPCO Technologies, Inc.
16804 Gridley Place
Cerritos, CA 90703

William A. Wheeler /(3)/                                                      18,092                         *
2011 Lombard Lane
Yakima, WA 98902

Nick A. Gerde /(7)/                                                          315,676                         *
c/o Pacific Aerospace & Electronics, Inc.
430 Olds Station Road, Third Floor
Wenatchee, WA 98801

Sheryl A. Symonds /(8)/                                                      265,999                         *
c/o Pacific Aerospace & Electronics, Inc.
430 Olds Station Road, Third Floor
Wenatchee, WA 98801

All executive officers and current directors as a group                    3,615,555                      8.91%
(8 persons) /(9)/
</TABLE>
____________



                                      102
<PAGE>

*    Less than 1%.

/(1)/  Shares that a person has the right to acquire within 60 days are treated
       as outstanding for determining the amount and percentage of Common Stock
       owned by such person but are not deemed to be outstanding as to any other
       person or group.

/(2)/  Includes (a) 4,000 shares issuable upon exercise of public warrants, (b)
       100,000 shares issuable upon exercise of another warrant, and (c)
       2,132,560 shares issuable upon exercise of vested stock options.

/(3)/  Includes 10,000 shares issuable upon exercise of vested stock options.
       Does not include 10,000 shares issuable upon exercise of unvested stock
       options.

/(4)/  Includes 160,000 shares issuable upon exercise of vested stock options.

/(5)/  Dr. Sharratt has been nominated to become a director of the Company at
       the annual meeting of shareholders to be held on October 10, 2000.

/(6)/  Includes 6,637 shares issuable upon exercise of vested stock options.
       Does not include 10,000 shares issuable upon exercise of unvested stock
       options.

/(7)/  Includes (a) 4,000 shares issuable upon exercise of public warrants, (b)
       25,000 shares issuable upon exercise of another warrant, and (c) 246,056
       shares issuable upon exercise of vested stock options.

/(8)/  Includes (a) 500 shares issuable upon exercise of public warrants and (b)
       260,000 shares issuable upon exercise of vested stock options.

/(9)/  Includes currently exercisable warrants and options to purchase up to
       2,968,753 shares of Common Stock.

                                      103
<PAGE>

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Employment Agreements.  The Company has entered into employment agreements with
Donald A. Wright, Werner Hafelfinger, Nick A. Gerde and Sheryl A. Symonds.  See
"Executive Compensation - Employment Agreements."

Condominium.  In November 1998, the Company entered into a Condominium Purchase
and Sale Agreement (the "Condominium Agreement") with Donald A. Wright, the
Company's Chief Executive Officer, President, and Chairman of the Board.
Pursuant to the Condominium Agreement, Mr. Wright agreed to purchase from the
Company a residential condominium unit within the Company's headquarters
building for a total purchase price of $175,000.  At the time the Condominium
Agreement was executed, the condominium had not been completed.  Upon
completion, the condominium had a value higher than Mr. Wright's purchase price.
As a result, Mr. Wright requested that the purchase be rescinded.  The Board of
Directors agreed to rescind the purchase, but amended Mr. Wright's employment
agreement to require Mr. Wright to reside in the condominium unit.  Mr. Wright
pays rent on the condominium unit of $750.00 per month.  In addition, the Board
approved an Option to Purchase, which grants to Mr. Wright the right to purchase
the condominium unit.  The option became exercisable February 1, 2000.  The
purchase price would be:  (i) $350,000 if the option is exercised prior to
February 1, 2001; (ii) $300,000 if the option is exercised on or after February
1, 2001, but prior to February 1, 2002; and (iii) $250,000 if the option is
exercised on or after February 1, 2002.  The option terminates ten business days
after Mr. Wright's employment relationship with the Company ceases for any
reason other than death.

                                      104
<PAGE>

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES
          AND REPORTS ON FORM 8-K

(a)(1)  Financial Statements

The following financial statements are included in this Annual Report on Form
10-K:

          Independent Auditors' Report dated July 28, 2000
          Consolidated Balance Sheets as of May 31, 1999 and 2000
          Consolidated Statements of Operations for the years ended May 31,
               1998, 1999 and 2000
          Consolidated Statements of Stockholders' Equity for the years ended
               May 31, 1998, 1999 and 2000
          Consolidated Statements of Cash Flows for the years ended May 31,
               1998, 1999 and 2000
          Notes to Consolidated Financial Statements

(a)(2)    Financial Schedules

All financial schedules are omitted because the required information is
inapplicable or the information is presented in the consolidated financial
statements or related notes.

(a)(3)    Exhibits

      Exhibit
      Number        Description
          2.1       Stock Purchase Agreement, dated as of June 1, 1999, between
                    Pacific Aerospace & Electronics, Inc. and the Shareholders
                    of Skagit Engineering & Manufacturing, Inc./(34)/
          2.2       Asset Purchase Agreement, dated as of March 22, 2000 between
                    Pacific Aerospace & Electronics, Inc., Skagit Engineering &
                    Manufacturing, Inc., Nova-Tech Engineering, Inc., and the
                    Shareholders of Nova-Tech Engineering, Inc./(31)/
          2.3       Exchange Agreement dated as of March 10, 2000, between
                    Pacific Aerospace & Electronics, Inc., and Post Advisory
                    Group, Inc., and the U.S. subsidiaries of Pacific Aerospace
                    & Electronics, Inc./(31)/
          2.4       Exchange Agreement dated as of March 17, 2000, between
                    Pacific Aerospace & Electronics, Inc., and Post Advisory
                    Group, Inc., and the U.S. subsidiaries of Pacific Aerospace
                    & Electronics, Inc./(31)/
          2.5       Exchange Agreement dated as of March 23, 2000, between
                    Pacific Aerospace & Electronics, Inc., and Post Advisory
                    Group, Inc., and the U.S. subsidiaries of Pacific Aerospace
                    & Electronics, Inc./(31)/
          2.6       Exchange Agreement dated as of March 30, 2000, between
                    Pacific Aerospace & Electronics, Inc., and Post Advisory
                    Group, Inc., and the U.S. subsidiaries of Pacific Aerospace
                    & Electronics, Inc./(31)/
          3.1       Articles of Incorporation of Pacific Aerospace &
                    Electronics, Inc./(6)/
          3.2       Amendment to Articles of Incorporation containing
                    Designation of Rights and Preferences of Series A
                    Convertible Preferred Stock, as corrected./(8)/
          3.3       Amendment to Articles of Incorporation containing
                    Designation of Rights and Preferences of Series B
                    Convertible Preferred Stock./(20)/
          3.4       Bylaws of Pacific Aerospace & Electronics, Inc., as
                    amended./(35)/
          4.1       Form of specimen certificate for Common Stock./(6)/

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<PAGE>

          4.2       Form of specimen certificate for public warrants./(6)/
          4.3       Form of specimen certificate for the Series A Convertible
                    Preferred Stock./(8)/
          4.4       Form of specimen certificate for the Series B Convertible
                    Preferred Stock./(20)/
          4.5       Form of Common Stock Purchase Warrant issued to holders of
                    the Series B Convertible Preferred Stock on May 15,
                    1998./(20)/
          4.6       Registration Rights Agreement, dated May 15, 1998 between
                    Pacific Aerospace & Electronics, Inc. and the holders of the
                    Series B Convertible Preferred Stock./(20)/
          4.7       Warrant Agreement between Interwest Transfer Co., Inc. and
                    PCT Holdings, Inc. dated July 1, 1996./(4)/
          4.8       Amendment No. 1, dated as of May 26, 2000, to the Warrant
                    Agreement, dated as of July 1, 1996, between Pacific
                    Aerospace & Electronics, Inc., as successor to PCT Holdings,
                    Inc., and Interwest Transfer Co., Inc./(32)/
          4.9       Purchase Warrant from Pacific Aerospace & Electronics, Inc.
                    to Paulson Investment Company, Inc., dated September 30,
                    1997./(20)/
         4.10       Purchase Warrant from Pacific Aerospace & Electronics, Inc.
                    to Chester L. Paulson, dated September 30, 1997./(20)/
         4.11       Purchase Warrant from Pacific Aerospace & Electronics, Inc.
                    to M. Lorraine Maxfield dated September 30, 1997./(20)/
         4.12       Common Stock Purchase Warrant No. 001 from Pacific Aerospace
                    & Electronics, Inc. to Donald A. Wright dated as of November
                    30, 1996./(10)/
         4.13       Common Stock Purchase Warrant No. 002 from Pacific Aerospace
                    & Electronics, Inc. to Nick A. Gerde dated as of November
                    30, 1996./(10)/
         4.14       Common Stock Purchase Warrant No. 003 from Pacific Aerospace
                    & Electronics, Inc. to Edward A. Taylor dated as of November
                    30, 1996./(10)/
         4.15       Common Stock Purchase Warrant from Pacific Aerospace &
                    Electronics, Inc. to Robert L. Smith Unified Credit Trust
                    dated as of February 5, 1998./(20)/
         4.16       Common Stock Purchase Warrant from Pacific Aerospace &
                    Electronics, Inc. to Gregory K. Smith dated June 3, 1997.
                    /(9)/
         4.17       Common Stock Purchase Warrant from Pacific Aerospace &
                    Electronics, Inc. to Nestor Wiegand dated June 3, 1997./(9)/
         4.18       Securities Purchase Agreement, dated May 15, 1998, between
                    Pacific Aerospace & Electronics, Inc. and the purchasers of
                    the Company's Series B Convertible Preferred Stock./(20)/
         4.19       Purchase Agreement dated as of July 23, 1998, between
                    Pacific Aerospace & Electronics, Inc., Balo Precision Parts,
                    Inc., Cashmere Manufacturing Co., Inc., Ceramic Devices,
                    Inc., Electronic Specialty Corporation, Morel Industries,
                    Inc., Northwest Technical Industries, Inc., Pacific Coast
                    Technologies, Inc., Seismic Safety Products, Inc., PA&E
                    International, Inc. and Friedman, Billings, Ramsey & Co.,
                    Inc. and BancBoston Securities Inc./(18)/
         4.20       Indenture dated as of July 30, 1998, between Pacific
                    Aerospace & Electronics, Inc., Balo Precision Parts, Inc.,
                    Cashmere Manufacturing Co., Inc., Ceramic Devices, Inc.,
                    Electronic Specialty Corporation, Morel Industries, Inc.,
                    Northwest Technical Industries, Inc., Pacific Coast
                    Technologies, Inc., Seismic Safety Products, Inc., PA&E
                    International, Inc. and IBJ Schroder Bank & Trust
                    Company./(18)/
         4.21       Registration Rights Agreement, dated as of July 30, 1998,
                    between Pacific Aerospace & Electronics, Inc., Balo
                    Precision Parts, Inc., Cashmere Manufacturing Co., Inc.,
                    Ceramic Devices, Inc., Electronic Specialty Corporation,
                    Morel Industries, Inc., Northwest Technical Industries,
                    Inc., Pacific Coast Technologies, Inc., Seismic Safety
                    Products, Inc., PA&E International, Inc. and Friedman,
                    Billings, Ramsey & Co.,

                                      106
<PAGE>

                    Inc. and BancBoston Securities Inc./(18)/
          4.22      Form of Global Note by Pacific Aerospace & Electronics,
                    Inc./(18)/
          4.23      Form of Subsidiary Guaranty from the U.S. subsidiaries of
                    Pacific Aerospace & Electronics, Inc./(25)/
          4.24      Form of Stock Purchase Agreement used in Spring 2000 private
                    placement./(31)/
          4.25      Securities Purchase Agreement among Pacific Aerospace &
                    Electronics, Inc., Strong River Investments, Inc., and Bay
                    Harbor Investments, Inc., dated as of July 27, 2000./(33)/
          4.26      Registration Rights Agreement between Pacific Aerospace &
                    Electronics, Inc., Strong River Investments, Inc., and Bay
                    Harbor Investments, Inc., dated as of July 27, 2000./(33)/
          4.27      Warrant between Pacific Aerospace & Electronics, Inc. and
                    Strong River Investments, Inc., dated as of July 27, 2000.
                    /(33)/
          4.28      Warrant between Pacific Aerospace & Electronics, Inc. and
                    Bay Harbor Investments, Inc., dated as of July 27, 2000.
                    /(33)/
          4.29      Warrant between Pacific Aerospace & Electronics, Inc. and
                    Strong River Investments, Inc., dated as of July 27, 2000.
                    /(33)/
          4.30      Warrant between Pacific Aerospace & Electronics, Inc. and
                    Bay Harbor Investments, Inc., dated as of July 27, 2000.
                    /(33)/
          4.31      Vesting Warrant between Pacific Aerospace & Electronics,
                    Inc. and Strong River Investments, Inc., dated as of July
                    27, 2000./(33)/
          4.32      Vesting Warrant between Pacific Aerospace & Electronics,
                    Inc. and Bay Harbor Investments, Inc., dated as of July 27,
                    2000./(33)/
          4.33      Placement Agent Warrant between Pacific Aerospace &
                    Electronics, Inc. and Rochon Capital Group, Ltd., dated as
                    of July 27, 2000./(34)/
          4.34      Common Stock Purchase Warrant between Pacific Aerospace &
                    Electronics, Inc. and Continental Capital & Equity
                    Corporation, dated April 17, 2000./(34)/
          4.35      Common Stock Purchase Warrant between Pacific Aerospace &
                    Electronics, Inc. and Continental Capital & Equity
                    Corporation, dated April 17, 2000./(34)/
          4.36      Common Stock Purchase Warrant between Pacific Aerospace &
                    Electronics, Inc. and Continental Capital & Equity
                    Corporation, dated April 17, 2000./(34)/
          4.37      Common Stock Purchase Warrant between Pacific Aerospace &
                    Electronics, Inc. and Continental Capital & Equity
                    Corporation, dated April 17, 2000./(34)/
         10.1       Amended and Restated Stock Incentive Plan./(5)/
         10.2       Amendment No. 1 to the Amended and Restated Stock Incentive
                    Plan./(19)/
         10.3       Amended and Restated Independent Director Stock Plan./(21)/
         10.4       1999 Stock Incentive Plan/(30)/
         10.5       1997 Employee Stock Purchase Plan./(11)/
         10.6       Employment Agreement, dated June 1, 1997, between Pacific
                    Aerospace & Electronics, Inc. and Donald A. Wright./(9)/
         10.7       Amendment No. 1 to Employment Agreement, dated January 29,
                    1999, between Pacific Aerospace & Electronics, Inc. and
                    Donald A. Wright./(27)/
         10.8       Employment Agreement, dated March 1, 1999, between Pacific
                    Aerospace & Electronics, Inc. and Werner Hafelfinger./(27)/
         10.9       Employment Agreement, dated June 1, 1997, between Pacific
                    Aerospace & Electronics, Inc. and Nick A. Gerde./(9)/
         10.10      Employment Agreement, dated September 1, 1997, between
                    Pacific Aerospace & Electronics, Inc. and Sheryl A.
                    Symonds./(12)/
         10.11      Promissory Note, dated March 18, 1998, from Pacific
                    Aerospace & Electronics, Inc.

                                      107
<PAGE>

                    to KeyBank National Association./(15)/
          10.12     Security Agreement, dated March 18, 1998, from Pacific
                    Aerospace & Electronics, Inc. to KeyBank National
                    Association./(15)/
          10.13     Loan Agreement, dated September 7, 1999, between Pacific
                    Aerospace & Electronics, Inc. and KeyBank National
                    Association./(29)/
          10.14     Promissory Note, dated September 22, 1998, from Pacific
                    Aerospace & Electronics, Inc. to KeyBank National
                    Association./(22)/
          10.15     Modification and/or Extension Agreement, dated October 6,
                    1999, between Pacific Aerospace & Electronics, Inc. and
                    KeyBank National Association/(29)/
          10.16     Commercial Security Agreement, dated September 7, 1999,
                    between Pacific Aerospace & Electronics, Inc. and KeyBank
                    National Association./(29)/
          10.17     Promissory Note, dated September 30, 1998, from Pacific
                    Aerospace & Electronics, Inc. to KeyBank National
                    Association./(22)/
          10.18     Deed of Trust, dated September 30, 1998, between Pacific
                    Aerospace & Electronics, Inc., KeyBank National Association
                    and Land Title Company, Chelan-Douglas County, Inc./(22)/
          10.19     Facility Letter, dated July 30, 1998, from Barclays Bank plc
                    to Aeromet International plc./(20)/
          10.20     General Terms Agreement No. BCA-65323-0458 dated December
                    20, 1999 between The Boeing Company and Pacific Aerospace &
                    Electronics, Inc. (U.S. Aerospace Group and European
                    Aerospace Group)./(31)/
          10.21     Special Business Provisions No. POP-65323-0519 December 20,
                    1999 between The Boeing Company and Pacific Aerospace &
                    Electronics, Inc. (U.S. Aerospace Group and European
                    Aerospace Group)./(1)(31)/
          10.22     Long Term Agreement No. 0108098 between Northrop Grumman
                    Corporation and Cashmere Manufacturing Co., Inc. effective
                    as of April 6, 1998./(1)(20)/
          10.23     Option to Purchase, dated January 29, 199, between Pacific
                    Aerospace & Electronics, Inc. and Donald A. Wright./(27)/
          10.24     Real Estate Agreement, dated January 15, 1999, between
                    Pacific Aerospace & Electronics, Inc. and the Port of Chelan
                    County./(27)/
          10.25     Incentive Compensation Program./(35)/
          10.26     Modification and/or Extension Agreement, dated September 6,
                    2000, between Pacific Aerospace & Electronics, Inc. and
                    KeyBank National Association./(35)/
          10.27     Modification and/or Extension Agreement, dated November 13,
                    2000, between Pacific Aerospace & Electronics, Inc. and
                    KeyBank National Association./(37)/
          10.28     Modification and/or Extension Agreement, dated November 28,
                    2000, between Pacific Aerospace & Electronics, Inc. and
                    KeyBank National Association./(37)/
          10.29     Modification and/or Extension Agreement dated January 5,
                    2001, between Pacific Aerospace & Electronics, Inc. and
                    KeyBank National Association./(37)/
          21.1      List of Subsidiaries./(34)/
          23.1      Consent of KPMG LLP./(38)/
          27.1      Financial Data Schedule./(34)/

_______________
/(1)/  Subject to confidential treatment.  Omitted confidential information was
       filed separately with the Securities and Exchange Commission.
/(2)/  Incorporated by reference to the Company's Annual Report on Form 10-KSB
       for the year ended May 31, 1995.
/(3)/  Incorporated by reference to Amendment No. 1 to the Company's
       Registration Statement on Form SB-2 filed on June 19, 1996.

                                      108
<PAGE>

/(4)/  Incorporated by reference to the Company's Annual Report on Form 10-KSB
       for the year ended May 31, 1996.
/(5)/  Incorporated by reference to the Company's Current Report on Form 10-QSB
       for the quarterly period ended November 30, 1996.
/(6)/  Incorporated by reference to the Company's Current Report on Form 8-K
       filed on December 12, 1996, reporting the reincorporation merger.
/(7)/  Incorporated by reference to the Company's Registration Statement of
       Certain Successor Issuers on Form 8-B filed on February 6, 1997.
/(8)/  Incorporated by reference to the Company's Current Report on Form 8-K
       filed on March 12, 1997, reporting the Series A Preferred Stock offering.
/(9)/  Incorporated by reference to the Company's Annual Report on Form 10-KSB
       for the fiscal year ending May 31, 1997.
/(10)/ Incorporated by reference to the Company's Registration Statement on Form
       S-8 filed on June 11, 1997.
/(11)/ Incorporated by reference to the Company's Definitive Proxy Statement for
       its 1997 Annual Shareholders Meeting, filed on August 28, 1997.
/(12)/ Incorporated by reference to the Post-Effective Amendment No. 1 to Form
       SB-2, filed on November 3, 1997.
/(13)/ Incorporated by reference to the Company's Quarterly Report on Form 10-
       QSB for the quarterly period ending November 30, 1997.
/(14)/ Incorporated by reference to the Company's Registration Statement on Form
       S-3 filed on December 3, 1997.
/(15)/ Incorporated by reference to the Company's Quarterly Report on Form 10-
       QSB for the quarterly period ending February 28, 1998.
/(16)/ Incorporated by reference to the Company's Current Report on Form 8-K/A,
       filed on May 1, 1998.
/(17)/ Incorporated by reference to the Company's Current Report on Form 8-K
       filed on July 10, 1998.
/(18)/ Incorporated by reference to the Company's Current Report on Form 8-K
       filed on August 14, 1998.
/(19)/ Incorporated by reference to the Company's Registration Statement on Form
       S-8 filed on November 7, 1997.
/(20)/ Incorporated by reference to the Company's Annual Report on Form 10-K for
       the fiscal year ending May 31, 1998.
/(21)/ Incorporated by reference to the Company's Definitive Proxy Statement
       filed on September 1, 1998.
/(22)/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q,
       and Form 10-Q/A, for the quarterly period ending August 31, 1998.
/(23)/ Incorporated by reference to the Company's Registration Statement on Form
       S-1 filed on October 30, 1998.
/(24)/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
       for the quarterly period ending November 30, 1998.
/(25)/ Incorporated by reference to Registration Statement on Form S-4 filed on
       November 25, 1998.
/(26)/ Incorporated by reference to Amendment No. 1 to Registration Statement on
       Form S-4 filed on January 20, 1999.
/(27)/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
       for the quarterly period ending February 28, 1999.
/(28)/ Incorporated by reference to the Company's Annual Report on Form 10-K
       filed on August 30, 1999.

                                      109
<PAGE>

/(29)/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
       for the quarterly period ending August 31, 1999.
/(30)/ Incorporated by reference to the Company's Definitive Proxy Statement
       filed on September 1, 1999.
/(31)/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
       for the quarterly period ending February 29, 2000.
/(32)/ Incorporated by reference to the Company's Current Report on Form 8-K
       filed on May 31, 2000.
/(33)/ Incorporated by reference to the Company's Current Report on Form 8-K
       filed on August 8, 2000.
/(34)/ Previously filed with this report.
/(35)/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
       for the quarterly period ending August 31, 2000.
/(36)/ Filed on October 13, 2000 with the first amendment on Form 10-K/A to this
       report.
/(37)/ Incorporated by reference to the Company's Quarterly Report on Form 10-Q
       for the quarterly period ending November 30, 2000.
/(38)/ Filed on January 18, 2001, with the second amendment on Form 10-K/A to
       this report.


(b)  Reports on Form 8-K.

     (i)  The Company filed a Current Report on Form 8-K on May 12, 2000
reporting the Nova-Tech acquisition.  This Form 8-K was amended by Form 8-K/A
(Amendment No. 1) filed on July 13, 2000, which included required financial
information.

     (ii) The Company filed a Current Report on Form 8-K on May 31, 2000,
reporting the extension of the expiration date of the Company's publicly traded
warrants from July 15, 2001 to July 15, 2003.

                                      110
<PAGE>

                                  SIGNATURES

  Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this amended report to be signed on
its behalf by the undersigned, thereunto duly authorized.

Date:  January 30, 2001.

                                   PACIFIC AEROSPACE & ELECTRONICS, INC.


                                   By /s/ DONALD A. WRIGHT
                                      -------------------------
                                   DONALD A. WRIGHT
                                   President and Chief Executive Officer


     Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this amended report has been signed below by the following persons on
behalf of the registrant and in the following capacities on January 30, 2001.

Signatures                         Title
----------                         -----


/s/ DONALD A. WRIGHT               President, Chief Executive Officer,
---------------------------        and Chairman of the Board
DONALD A. WRIGHT                   (Principal Executive Officer)


/s/ NICK A GERDE                   Vice President Finance, Chief Financial
---------------------------        Officer, Treasurer, and Assistant Secretary
NICK A. GERDE                      (Principal Financial and Accounting Officer)


/s/ WERNER HAFELFINER              Director, Vice President Operations and
---------------------------        Chief Operating Officer
WERNER HAFELFINGER


/s/ DALE L. RASMUSSEN              Director
---------------------------
DALE L. RASMUSSEN


/s/ WILLIAM A. WHEELER             Director
---------------------------
WILLIAM A. WHEELER


/s/ ROBERT M. STEMMLER             Director
---------------------------
ROBERT M. STEMMLER


/s/ GENE C. SHARRATT, Ph.D.        Director
---------------------------
GENE C. SHARRATT, Ph.D.

                                      111