<PAGE>

                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            Washington, D.C.  20549
                                   FORM 10-K

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934
                    For the fiscal year ended May 31, 2001

[_]  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 10, 2001: approximately $4,592,180.

Indicate the number of shares outstanding of each of the registrant's classes of
common equity, as of August 27, 2001: common stock, $.001 par value: 39,315,309
shares.

Documents Incorporated by Reference:

Part III - Portions of the registrant's definitive proxy statement to be issued
in conjunction with registrant's 2001 annual meeting of shareholders.

Exhibits - Certain Exhibits referred to on the list of Exhibits, contained in
Item 14 of this report.
<PAGE>

                               TABLE OF CONTENTS
                               -----------------

<TABLE>
<CAPTION>
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.............................................    36

Item 7 -   Management's Discussion and Analysis of
           Financial Condition and Results of Operations.......................    38

Item 7A -  Quantitative and Qualitative Disclosures About Market Risk..........    51

Item 8 -   Financial Statements................................................    52

Item 8A -  Selected Quarterly Financial Data...................................    91

Item 9 -   Changes in and Disagreements with Accountants on
           Accounting and Financial Disclosure.................................    93

PART III

Item 10 -  Directors and Executive Officers of the Company.....................    94

Item 11 -  Executive Compensation..............................................    94

Item 12 -  Security Ownership of Certain Beneficial
           Owners and Management...............................................    94

Item 13 -  Certain Relationships and Related Transactions......................    94

Item 14 -  Exhibits, Financial Statement Schedules and Reports on Form 8-K.....    95

SIGNATURES.....................................................................   103
</TABLE>

                                      (i)
<PAGE>

                                    PART I

ITEM 1.  DESCRIPTION OF BUSINESS

Overview

Pacific Aerospace & Electronics, Inc. is an 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.

Pacific Aerospace has struggled financially since late 1998, when the commercial
airplane industry suffered a downturn at approximately the same time that we
incurred high-cost, high-yield debt to finance the acquisition of our European
Aerospace Group.  We reported a net loss of $75,720,000 for our fiscal year
ended May 31, 2001.  This followed net losses of $13,049,000 and $12,869,000 for
our fiscal years ended May 31, 2000 and May 31, 1999, respectively.
Approximately $53.8 million of the net loss reported for fiscal 2001 related to
non-cash impairment charges and a write-off of deferred tax assets.  As of May
31, 2001, we had approximately $64 million in principal amount of 11 1/4% senior
subordinated notes and approximately $13.7 million in principal amount of 18%
senior secured debt outstanding.

For our fiscal year ended May 31, 2001, we had net sales of approximately $109
million, with our European Aerospace Group contributing approximately $52
million in net sales.  In October 2000, we announced our intention to sell our
European Aerospace Group in order to reduce our outstanding debt.  Although we
are actively pursuing the sale of that group, we have not reached an agreement
to date with any prospective purchaser, and we do not know whether we will be
successful in selling the group.  If we are successful in selling the group, we
do not know the amount of net proceeds that would be available to reduce our
outstanding debt.

In March 2001, we announced a plan to restructure our operations by shrinking
our aerospace business through downsizing and divestiture of non-core, low-
margin and unprofitable business units.  We have been implementing this plan to
streamline our operations and focus our attention and resources on growing our
technology-based electronics businesses.  As part of this plan, we closed the
fabrication operations of our U.S. Aerospace Group's Engineering & Fabrication
Division in Sedro-Woolley, Washington, in April 2001 and sold the assets related
to those operations in May 2001.  In addition, we shut down the Tacoma,
Washington, operations of our U.S. Aerospace Group's Casting Division in
November 2000 and sold the assets of the division's Entiat operation in June
2001.  We also sold the relay business of our U.S. Electronics Group's Display
Division in March 2001.

On August 1, 2001, we announced that we did not make an approximately $3.6
million interest payment on our 11 1/4% senior subordinated notes that was due
on that date.  Under the indenture governing the 11 1/4% senior subordinated
notes, the Company has a 30-day grace period in which to make the interest
payment before an event of default occurs.  We will not be able to make the
payment

                                       1
<PAGE>

before expiration of the 30-day grace period on August 31, 2001. We are
currently in negotiations with the holders of approximately 98% of the 11 1/4%
senior subordinated notes regarding a possible restructuring of the Company's
debt and equity structure.

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.

                                       2
<PAGE>

Corporate History

We acquired all but one of our divisions in a series of acquisitions that began
in 1990.  We accounted for each of the acquisitions as a purchase.  The
following chart identifies, as of May 31, 2001, our three operational groups,
the operating divisions that comprise those groups, the year of each
acquisition, and the locations of our operations.

In March 2001, we announced a plan to restructure our operations by shrinking
our aerospace business through downsizing and divestiture of non-core low-margin
and unprofitable business units.  We intend to streamline our operations and
focus our attention and resources on growing our technology-based electronics
businesses.  As part of this plan, we closed our fabrication operations in
Sedro-Woolley, Washington in April 2001 and sold the assets related to those
operations in May 2001.  In addition, we sold the relay business of our U.S.
Electronics Group's Display Division in March 2001, and we sold the assets of
our U.S. Aerospace Group's Casting Division in June 2001.  We have also
announced our intention to sell our European Aerospace Group.

This Annual Report on Form 10-K relates to the fiscal year ended May 31, 2001.
The description of the Company's business in this report focuses on the
operations as they were organized during most of 2001.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                                            Location as of
                                                     Year Acquired           May 31, 2001                     Recent Changes
------------------------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>                 <C>                             <C>
U.S. ELECTRONICS GROUP
------------------------------------------------------------------------------------------------------------------------------------
Interconnect Division                                1990 and 1998       Wenatchee, Washington                      N/A
------------------------------------------------------------------------------------------------------------------------------------
Filter Division                                      1995                Wenatchee, Washington                      N/A
------------------------------------------------------------------------------------------------------------------------------------
Bonded Metals Division                               1997                Sequim, Washington                         N/A
------------------------------------------------------------------------------------------------------------------------------------
Display Division                                     1998                Vancouver, Washington           Being moved to Wenatchee,
                                                                                                         Washington; target
                                                                                                         completion date 8/31/01.
                                                                                                         Assets of relay business
                                                                                                         sold in March 2001.
------------------------------------------------------------------------------------------------------------------------------------
Applied Technology Division                          N/A *               Wenatchee, Washington                      N/A
------------------------------------------------------------------------------------------------------------------------------------
U.S. AEROSPACE GROUP
------------------------------------------------------------------------------------------------------------------------------------
Casting Division                                     1995 and 1998       Entiat, Washington              Entiat assets sold in June
                                                                                and                      2001.
                                                                         Tacoma, Washington              Tacoma foundry shut down
                                                                                                         in November 2000.
------------------------------------------------------------------------------------------------------------------------------------
Machining Division                                   1994 and 1995       Wenatchee, Washington                      N/A
------------------------------------------------------------------------------------------------------------------------------------
Engineering & Fabrication Division                   1999 and 2000       Sedro-Woolley, Washington       Sedro-Woolley operations
                                                                         and Edmonds, Washington         closed in April 2001 and
                                                                                                         assets sold in May 2001.
------------------------------------------------------------------------------------------------------------------------------------
EUROPEAN AEROSPACE GROUP
------------------------------------------------------------------------------------------------------------------------------------
Casting Division                                     1998                Sittingbourne, England                     N/A
                                                                         Rochester, England and
                                                                         Worcester, England
------------------------------------------------------------------------------------------------------------------------------------
Forming Division                                     1998                Welwyn Garden City, England                N/A
                                                                         and
                                                                         Birmingham, England
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

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

                                       3
<PAGE>

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"), Goodrich Corporation's Aerostructures Group ("Goodrich",
formerly known as BFGoodrich Company), The Boeing Company ("Boeing"), European
Aeronautic Defence and Space Company N.V. ("EADS"), GKN Westland Aerospace, Inc.
("GKN Westland"), Honeywell International Inc. Lockheed Martin Corporation,
Northern Telecom Ltd. ("Northern Telecom"), Vought Aircraft Industries, Inc.
("Vought", formerly Northrup Grumman Corporation's commercial aerostructures
group), Paccar Inc. ("PACCAR"), Parker Hannifan Corporation, Raytheon Company
("Raytheon"), Rolls-Royce plc ("Rolls-Royce"), and TRW Inc.

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
integrated 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, parts and assembly tooling 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 23 U.S. patents and has applied for two additional 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.  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

                                       4
<PAGE>

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.

Integrate and Consolidate Operations

During the 2001 fiscal year, we aggressively integrated and consolidated our
operations and, where necessary, shut down and sold unprofitable and non-core
operations. We currently plan to focus our growth efforts internally to
integrate manufacturing processes, develop and refine our proprietary
technologies and new products, expand sales and marketing efforts, and enhance
engineering and value-added processes.  By doing so, we expect to reduce costs
and increase operating efficiencies, while providing more complete and faster
solutions to our customers.

Enhance Sales and Marketing Functions

During the 2001 fiscal year, we evaluated our sales and marketing systems and
performance and determined that changes were required to be able to successfully
accomplish our goals.  As a result of this reevaluation, we have eliminated our
centralized marketing department and refocused each of our divisions on sales
and marketing.  We coordinate the divisions' efforts through regular meetings to
ensure that we have the capability to combine the technologies and manufacturing
abilities of our different divisions to meet our customers' needs for more
complete systems.

Offer Complete Solutions

At the same time, we have continued to vertically integrate 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 integrated systems and pre-assembled parts.  By
producing products that integrate our various areas of expertise, we hope 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.  We do not just make parts based on a
drawing - we are able to provide design, modeling and prototyping 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, have been expanding outside their historical
roles into new industries, the Applied Technology Division has been exploring

                                       5
<PAGE>

opportunities to supply components to industries such as the fuel cell and
advanced medical products industries.  As a result of these efforts, we plan not
only to reduce our reliance on the cyclical aerospace industry, but also to
become an important part of emerging industries.


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 Boeing's 2001 Current Market Outlook, Boeing estimated growth rate of
world air travel over the next 20 years will be approximately 4.7% per year.
Airbus forecasts a similar growth rate, of 4.9% per year.  Boeing has also
projected that the world jet fleet will grow to 32,955 passenger and cargo jets
in 2020 and that the total market potential for new commercial airplanes between
2001 and 2020 is 23,460 airplanes.

In 2000, Boeing delivered 489 new commercial aircraft, compared to 620 new
commercial aircraft in 1999 and 563 in 1998.  In 2000, Airbus delivered 311 new
commercial aircraft, compared to 294 in 1999 and 229 in 1998.  Boeing has
announced that it delivered 305 commercial aircraft through July 31, 2001, as
compared to 275 delivered through July 31, 2000.  As of July 31, 2001, Boeing
had received orders in 2001 for 192 commercial aircraft, as compared to orders
for 342 commercial aircraft during the same period of 2000.  Total Boeing orders
in 2000 and 1999 were 611 and 391, respectively.  As of July 31, 2001, Airbus
had announced orders in 2000 for 318 commercial aircraft. Airbus had total
orders for 520 aircraft in 2000.

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.  Aircraft manufacturers
and defense contractors have increasingly 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 integrated 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

                                       6
<PAGE>

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 meet their customers' needs.

Electronics

The electronics industry is enjoying growth in the Company's specific sectors,
and researchers expect the sector to continue to grow through at least 2004.
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.

The electronics industry is experiencing a dynamic period of mergers and
acquisitions, with BAE Systems buying a Lockheed Martin Sanders division,
Raytheon acquiring Hughes divisions, Northrop Grumman purchasing Litton Guidance
& Controls, and DRS purchasing Texas Instruments divisions, to list a few.  Each
of these transactions offered the Company new opportunities to experience
expanded positive exposure within our technology niche.  Many of these industry
leaders are involved with the Company in multi-year programs that we expect to
continue for several years.  When balanced against the recent slowdown and
significant reductions in the telecommunications industry, we expect these
opportunities to result in modest growth in the Company's U.S. Electronics
Group.

Products, Processes and Markets

Our products, manufacturing processes and markets in fiscal 2001, and the
industry segments in which we operated during fiscal 2001, are summarized below.
As noted, we have experienced some changes since the latter part of fiscal 2001.
We sold the relay business of the U.S. Electronics Group's Display Division in
March 2001.  We shut down the Tacoma operations of the U.S. Aerospace Group's
Casting Division in November 2000 and sold the assets of its Entiat operations
in June 2001.  In addition, we shut down the fabrication operations of the U.S.
Aerospace Group's Engineering & Fabrication Division in April 2001, and sold its
assets in May 2001.

For financial information about operational segments and geographic areas, see
"Notes to Consolidated Financial Statements - Note 5" in the Company's
consolidated financial statements for May 31, 2001.

                                       7
<PAGE>

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------------
                                                    Manufacturing
Segment        Group             Division           Processes                  Sample Products
------------------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------------------
<S>            <C>            <C>                 <C>                          <C>
               U.S.             Interconnect      Design and manufacture       Electronic connectors, packages and assemblies with
               Electronics                                                     ceramic and glass hermetic seals
                              ------------------------------------------------------------------------------------------------------
                                Filter            Design and manufacture       Ceramic discoidal electromagnetic filters and
    E                                                                          capacitors
    L                         ------------------------------------------------------------------------------------------------------
    E                           Bonded Metals     Explosive bonding and        Metallurgically welded metals for use in
    C                                             forming of dissimilar        electronic connectors and assemblies
    T                                             metals
    R                         ------------------------------------------------------------------------------------------------------
    O                           Display           Design and manufacture       Sunlight readable displays; EMI filters; ruggedized
    N                                                                          displays; relays and solenoids
    I
    C                                                                          (Relay operations sold in March 2001)
    S                         ------------------------------------------------------------------------------------------------------
                                Applied           Design and manufacture       Medical product components; fuel cell components
                                Technology
------------------------------------------------------------------------------------------------------------------------------------
                                Casting           Sand; lost foam; and         Aircraft and truck parts
                                                  permanent mold casting
                                (Tacoma foundry
    A                           shut down in
    E                           November 2000)
    R
    O                           (Entiat assets
    S          U.S.             sold in June
    P          Aerospace        2001)
    A                         ------------------------------------------------------------------------------------------------------
    C                           Machining         Precision machining          Aircraft parts; medical
    E                                             and assembly                 products; industrial products
                              ------------------------------------------------------------------------------------------------------
                                Engineering &     Design; metal                Tooling and structures for aircraft manufacture;
                                Fabrication       fabrication                  aviation tool design; factory integration and
                                                                               automation; aircraft flight structure design
                                (Fabrication
                                operations shut
                                down in April
                                2001; assets
                                sold in May
                                2001)
             -----------------------------------------------------------------------------------------------------------------------
                                Forming           Hot and superplastic         Jet engine bulkhead components; airframe and engine
                                                  titanium forming; cold       details; aircraft skin panels; leading edges
               European                           stretch aluminum
               Aerospace                          forming
                              ------------------------------------------------------------------------------------------------------
               (Currently       Casting           Sand casting;                Aircraft parts; aircraft engine parts; high
               for sale)                          investment casting;          performance motorsport engine and gearbox parts
                                                  Sophia casting;
                                                  machining
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

                                       8
<PAGE>

The following chart shows the percentage of total revenue from each division for
the past three fiscal years.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------
Segment        Group          Division                    Years Ended May 31,
-----------------------------------------------------------------------------------------------
<S>        <C>             <C>             <C>              <C>              <C>
                                                     1999             2000             2001
                                                    -----            -----            -----
-----------------------------------------------------------------------------------------------

E               U.S.        Interconnect            13.30%           12.80%           14.50%
L                           ----------------------------------------------------------------------
E           Electronics           Filter              *                *                *
C                           ----------------------------------------------------------------------
T                                Bonded
R                                Metals               *                *                *
O                           ----------------------------------------------------------------------
N                                Display              *                *                *
I                           ----------------------------------------------------------------------
C                                Applied             N/A               *                *
S                               Technology
--------------------------------------------------------------------------------------------------

A                                Casting            12.60%           12.80%             *
E                           ----------------------------------------------------------------------
R               U.S.            Machining           16.30%             *              11.10%
O                           ----------------------------------------------------------------------
S            Aerospace         Engineering
P                                   &                N/A               *                *
A                              Fabrication
C        -----------------------------------------------------------------------------------------
E            European           Forming             25.10%           24.90%           21.50%
                            ----------------------------------------------------------------------
             Aerospace
                                Casting             24.10%           25.60%           25.70%
--------------------------------------------------------------------------------------------------
</TABLE>

     *  Less than 10%

     U.S. Electronics Group

Our U.S. Electronics Group develops, designs and produces a diverse array of
components, ranging from tiny implantable medical devices to aircraft cockpit
displays and huge components for the Space Shuttle main engine. Virtually all of
our products are created to withstand the rigors of some hostile environment.
Inter-divisional synergy is very important to the U.S. Electronics Group, as it
permits us to develop and produce unique products and technologies.  For
example, the patented application of the group's Bonded Metals Division is at
the very heart of the Interconnect Division's lightweight hermetic technology.

                                       9
<PAGE>

     Interconnect Division

In Wenatchee, Washington, our Interconnect Division designs and produces
lightweight, hermetically sealed electronics housings and components for the
space, medical, energy and military markets. Utilizing proprietary sealants such
as our Kryoflex(R) ceramic and other patented and proprietary technologies, the
division is known as a supplier of some of the most durable products on the
market today. Applications include many high profile projects, such as the
International Space Station, the Javelin Missile, the Longbow Missile, the F-15,
F-18 and F-22 current production military aircraft, the THAD Missile and the
Joint Strike Fighter aircraft.

Utilizing our proprietary and patented ceramic joining technologies, the
Interconnect Division has developed and continues to develop innovative
solutions for components used in a number of medical applications.  For example,
we make components for implantable neuro-stimulators for the management of such
maladies as incontinence, epilepsy, Hodgkins disease, loss of muscle control,
and chronic pain. Other medical component applications include a
zirconia/titanium housing for a cochlear implant device, implantable
defibrillator components, a left ventricular assist device, and artificial heart
components.

The "state of the art" machining capability within the Wenatchee facility allows
us to comply with the very precise tolerances (up to 1/10,000 inch) needed for
the production of satellite, avionics and missile components. When combined with
the application of our proprietary Kryoflex(R) ceramic sealant, this capability
allows the Company to produce extremely rugged electronic connectors for
applications such as the oil industry where "down hole" temperatures exceed 400
degrees Fahrenheit and pressures exceed 30,000 pounds per square inch.
Kryoflex(R) is available in several formulations that are selected according to
the materials to be joined and conditions to be endured.

With our new (patent granted in 2001) metal matrix composite packaging
technology, we have undertaken projects for the military radar industry, with
current projects in both naval and airborne radar applications. Providing the
required features of light weight, thermal conductivity and hermeticity, these
systems are utilized within the latest Aegis class cruisers, as well as the F-18
and F-22 aircraft, in preference to the traditional materials, which have both
higher weight and significantly higher cost.  Initial market responses indicate
that this new and unique patented technology may provide significant growth
opportunities in the future.

The Interconnect Division holds a 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.

     Filter Division

Our U.S. Electronics Group's Filter Division designs and manufactures very
small, specialized multilayer discoidal (round) ceramic capacitors and EMI
(electro-magnetic interference) filters for the electronics industry.
Traditionally specializing in high reliability devices for the military and
aerospace industries, the Filter Division has enjoyed significant recent success
in the telecommunications industry

                                       10
<PAGE>

as well. During the past year, the Filter Division has released to market a
series of high current EMI filters that represent the smallest 25, 50 and 100
amp EMI filters available on the market today. This is a significant advantage
to power applications requiring high current and high package density. The
Filter Division is also producing components for the heart pacer industry.
During the past year, we have made significant progress in the area of labor
reducing automation. Fully automatic testing stations and computerized numerical
control ("CNC") turning stations are in use in our facility today due to this in
house development. This division also produces some very specialized filter
components for use by the Interconnect Division. The division has received a
number of military and industry qualification ratings. The division also holds a
certificate of registration to the ISO 9001 standard and a compliance
certificate to the AS 9000 standard.

     Bonded Metals Division

Our U.S. Electronics Group's Bonded Metals Division, located in Sequim,
Washington, produces a wide variety of explosively bonded dissimilar metals, as
well as other complex metal forms and conditions.  Applications of this
explosively bonded technology range from components for surgical instruments,
such as endoscopes, to "sputtering targets" utilized for vapor deposition of
exotic metals onto critical surfaces such as semiconductor devices, to mirrors
for medical or spacecraft uses. One major application for these products is in
the marine field, where they provide a solution to the ageless problem of
galvanic corrosion.  The Bonded Metals Division utilizes explosive metal forming
to produce components for jet aircraft engines, rocket nozzle components for the
Space Shuttle, and complex aircraft chassis components.  The Bonded Metals
Division is the only known U.S. source for explosive metal forming at this time.
Shock hardening (a type of work hardening) of metals is another important
product of the Bonded Metals Division. Products include railroad intersection
components that are hardened to extend their service life and cutting teeth for
tunnel boring machines.  Future plans for this division include moving
operations to the Wenatchee area to capitalize on the consolidation of services.
We currently plan to proceed with this relocation process as soon as an
acceptable remote blast site is located and secured.

     Display Division

Flat Panel Displays.  The Display Division designs and manufactures enhancements
for liquid crystal displays (LCDs) intended for use in a wide variety of hostile
environments.  Enhancement features include optical filters to minimize the
effect of high ambient light sources, such as direct sunlight, for improved
contrast, EMI filters to protect sensitive electronic instruments from unwanted
electrical interference, and vandal shields to protect the LCD itself from
physical abuse. Other options include heater elements for low temperature
applications (up to -40 Celsius), touch sensors, and high efficiency backlights.
Filter elements and vandal shields consisting of special technical grade glasses
are very carefully bonded directly to the LCD with characteristically matched
and selected epoxies.  Applications for these complex total solution
enhancements include such harsh environments as aircraft cockpit displays, in-
flight entertainment systems, air traffic control towers, all weather outdoor
kiosks, emergency vehicles, medical instruments, commercial trucking, and marine
GPS (global positioning satellite) receiver units.  The Display Division has
been selected to be a strategic "value added partner" with NEC Electronics,
Inc., a world leader in display technology.  This is a very prestigious
relationship in the LCD community.  The division's operations are compliant with
ISO9002 and AS9000 quality systems.

Relays and Solenoids.  Until March 2001, the Display Division designed,
manufactured and marketed electromechanical devices, such as relays, solenoids,
sensors, electronic assemblies, actuators, and time

                                       11
<PAGE>

delays used in a wide variety of satellite, aircraft and military hardware
applications. We sold these operations in March 2001.

     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 and implantable medical products
industries.  The division is focusing on providing solutions in the areas of
diffusion bonding, ceramic/metals joining, exotic metals composites,
interconnect stability, and thermal stress distribution with biocompatible
materials.  In the fuel cell area, the division develops and manufactures
processes for the assembly of fuel cells stacks, heat exchangers and fuel
reformers for pem and solid-oxide fuel cells.  The division also has applied our
zirconia-metal fusion technology to the manufacture of a solid-oxide
electrolyzer for use in space exploration.  Additional research is being
performed on planar fuel cell stacks.  The division has also used the zirconia-
metal fusion technology to assist a manufacturer of neurostimulator devices in
overcoming technological barriers.  We have produced titanium-copper-molybdenum
composite electronic enclosures and applied for a patent related to this
technology.  This technology allows us to produce lighter, more durable
electronics packages with improved thermal conductivity.  The Applied Technology
Division is still in its infancy, but our goal is to expand this division by
leveraging and finding new applications for our existing and new materials
science and emerging manufacturing technology developments.

U.S. Aerospace Group

     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 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.  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 are affected significantly by fluctuations in the aerospace
industry.  As a result, we believe it is important to reduce the division's
dependence on aerospace work.  During fiscal 2001, the Machining Division began
targeting and receiving orders from other industries that have a need for high
technology precision machining, such as the medical and semiconductor equipment
industries.  We are continuing to look for ways to offer our capabilities to
leaders in these new markets.

                                       12
<PAGE>

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.

     Engineering & Fabrication Division

Our Engineering & Fabrication Division, located in Mountlake Terrace,
Washington, provides turnkey aerospace design solutions, primarily for the
commercial aerospace and defense markets.  Our products include static tooling,
automated manufacturing systems, flight structures, and other related
commodities.  Our business niche includes specialized products, such as laser
alignment and positioning systems, industrial transporters, guidance systems,
and automated drilling and fastening systems.  In addition, a new business unit,
involving the design and development of aircraft flight structures, has been
added to complement our suite of capabilities.  With focus on lean manufacturing
methods and efficient design practice, we believe that this venture offers high
value to our customers and positions us well for strategic growth.  Our
engineering staff includes highly experienced mechanical engineers, electrical
engineers, automation engineers, and programmers.   We have extensive CAD design
capability (CATIA, UG and Autocad), as well as advanced virtual simulation
competency, using Delmia-Igrip.  Our stress engineers are well versed in the
latest Finite Element Analysis software.  We have also developed a staff of
trained project managers.


     Casting Division

Until June 14, 2001, our U.S. Aerospace Group's Casting Division designed and
manufactured precision cast aluminum parts using permanent mold, sand, and lost
foam casting technologies in Entiat, Washington.  In addition, until November
30, 2000, the division designed and manufactured aluminum, bronze, iron, and
steel parts using sand casting technology in Tacoma, Washington.  The division's
cast parts were sold principally to the transportation and aerospace industries.
We closed our Tacoma facility as of November 30, 2000, and we sold the assets of
our Entiat operations on June 14, 2001.

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

                                       13
<PAGE>

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 21 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 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

                                       14
<PAGE>

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 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.

Proposed Sale.  For our fiscal year ended May 31, 2001, we had net sales of
approximately $109 million, with the European Aerospace Group contributing
approximately $52 million in net sales.  On October 31, 2000, we announced our
intention to sell our European Aerospace Group in order to reduce our
outstanding debt.  As of May 31, 2001, we had approximately $64 million in
principal amount of 11 1/4% senior subordinated notes and approximately $13.7
million in senior secured debt outstanding.  Although we are actively pursuing
the sale of the European Aerospace Group, we have not yet reached an agreement
with any prospective purchaser, and we do not know whether we will be successful
in selling that group.   If we are successful, we do not know the amount of net
proceeds that would be available to reduce our outstanding debt.  We are
required to pay our senior secured lenders at least $7.5 million upon the sale
of our European Aerospace Group.  We have received several bona-

                                       15
<PAGE>

fide preliminary and final offers to purchase the group. If these offers
approximate the final negotiated sales price for the group and we obtain
required consents to the sale, the offers indicate that we have incurred an
impairment loss related to goodwill and equipment of approximately $37 million.
Consequently, we recorded an impairment loss related to our European Aerospace
Group goodwill of $25 million for the quarter ended February 28, 2001, and an
additional impairment loss of $12 million related to goodwill and equipment for
the quarter ended May 31, 2001.

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 2001
fiscal year, we transferred responsibilities for sales and marketing to each of
our operating divisions.  We also reviewed our outside sales representative
networks and made changes in order to take advantage of synergies and conduct
sales efforts more efficiently and effectively.  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 two years, 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 emphasize cross-selling and coordination of sales and marketing
efforts between and among our operating groups.

Customers

Our top ten customers in terms of revenues during fiscal 2001 were Boeing, BAE
Systems, Aermacchi, Northern Telecom, Rolls-Royce, GKN Westland, PACCAR,
Raytheon, Goodrich, and Vought.  Only the top two customers individually
accounted for 5% or more of our revenues, with Boeing at approximately 12.5%,
BAE Systems at approximately 8.8%.  Together, our top ten customers accounted
for approximately 50% of our sales during fiscal 2001.  In fiscal 2001, we
produced machined and cast metal aircraft components for Boeing and for BAE
Systems.  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 have

                                       16
<PAGE>

historically been divided approximately equally between the United States and
Europe. One of our goals has been 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 have emphasized 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 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. 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, 2001, we had purchase orders and contractual
arrangements, excluding those at our U.S. Aerospace Group's Casting Division,
evidencing anticipated future deliveries, which we treat as backlog, through
fiscal year 2003 of approximately $65 million. We expect to deliver
approximately $55 million of this backlog in fiscal year 2002. As of May 31,
2000, we had backlog through fiscal year 2001 of approximately $80 million,
which included backlog of the U.S. Aerospace Group's Casting Division. 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, and Spectrum Control, Inc. In the hot and
superplastic forming market, our primary competitor is Jet Die Barnes. 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.

                                       17
<PAGE>

Raw Materials

Our European Aerospace Group obtains approximately 65% of its titanium from one
supplier and is subject to a lead time of approximately 26 to 33 weeks in
ordering and obtaining titanium. Recently, this lead time was as long as 65
weeks. 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 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 28 U.S. patents, four U.S. patent applications pending (including one
allowed application), one PCT International patent applications pending, three
patent applications pending in non-U.S. jurisdictions, and one 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 nine
patents expiring over the next four years. These nine patents, as well as
several other patents that recently expired, relate to products manufactured by
our U.S. Electronics Group and constituted less than 1% of our consolidated
revenue in fiscal 2001. 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

                                       18
<PAGE>

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, 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 until August 2001, we leased 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

                                       19
<PAGE>

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 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, 2001, the Company had approximately 1,041 employees, of whom
approximately 926 were engaged in manufacturing functions, 32 in sales and
marketing functions, 75 in administrative functions, and 8 in executive
functions. Of the employees, approximately 243 were employed by the U.S.
Aerospace Group, 532 by the European Aerospace Group, 229 by the U.S.
Electronics Group, and 37 by the corporate group. As of May 31, 2001, 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, a
net loss of $13,049,000 for our fiscal year ended May 31, 2000, and a net loss
of $75,720,000, including impairment losses, for our fiscal year ended May 31,
2001. We believe that we will continue to incur net losses into fiscal 2002 and
that such losses may be substantial. For our quarters ended February 28, 2001
and May 31, 2001, we recorded impairment losses related to our European
Aerospace Group goodwill and equipment and impairment losses related to other
intangibles and property. We also wrote off substantially all our deferred
income tax assets at February 28, 2001. 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, to finance
production and to realize acceptable gross profits on the products we sell.
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.

                                       20
<PAGE>

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. The independent auditors' report for fiscal year 2001 is a
disclaimer of opinion. 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.

We need to raise additional cash or we will not be able to fund our operations
or to make payments on our loans when they are due.

Our existing cash and credit facilities will not be sufficient to meet our
obligations as they become due. 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 and financing activities. We cannot predict
accurately the amount or timing of our future cash needs. We did not make a
semi-annual interest payment of approximately $3.6 million on our 11 1/4% senior
subordinated notes that was due on August 1, 2001, and we will not be able to
make that payment before expiration of the 30-day grace period that expires on
August 31, 2001. As a result, we expect an event of default to occur under those
notes. Such an event of default would also cause events of default under certain
of our other debt instruments, including our 18% senior secured loan. In
addition, we may currently be in default under our 18% senior secured loan for
failure to make the August 1, 2001 interest payment on our 11 1/4% senior
subordinated notes. To date, our secured lenders have not exercised any remedies
with respect to any possible default, but we can provide no assurance that they
would not exercise their remedies as a result of any default. Possible remedies
include acceleration of the due dates of our debt. We did not make our February
1, 2001 interest payment on our 11 1/4% senior subordinated notes until March 2,
2001, which was one day before expiration of the 30-day grace period. We made
the interest payment from the proceeds of an approximately $13.8 million senior
secured loan that closed on March 1, 2001. The March 1, 2001 loan bears interest
at 18% per annum, payable quarterly. To date, we have made interest payments on
the 18% senior secured loan on time. We have the right to defer and accrue a
portion of the quarterly interest payments, up to 1 1/4% per quarter, for up to
a year at the time of any interest payment. We exercised this right for our
interest payments made in March and June 2001. We do not currently have
sufficient cash to make the September 30, 2001 interest payment on our 18%
senior secured loan, and we will need to raise additional cash to make that
payment. We also need to raise additional cash to make other future payments on
our debt and to fund our operations. If we are unable to obtain sufficient cash
when needed to fund our operations, to make our loan payments, and to pay our
other obligations when due, we may be forced to seek protection from creditors
under the bankruptcy laws. We are currently in negotiations with the holders of
approximately 98% of the 11 1/4% senior subordinated notes regarding a possible
restructuring of the Company's debt and equity structure. We do not currently
know whether we will be successful in negotiating a restructuring or whether
such a restructuring would occur inside or outside of bankruptcy.

                                       21
<PAGE>

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 may be
forced to reduce or delay capital expenditures or to dispose of material assets
or operations, potentially at a substantial loss. If we are unable to pay our
debt, we may need to restructure or refinance our debt at potentially higher
rates of interest. Alternatively or in addition, we may need to seek additional
equity capital or exchange debt for substantial amounts of equity, which would
significantly dilute the value of the shares held by our existing shareholders.
We may not be able to choose any of these alternatives or complete them on
satisfactory terms. If we fail to make our debt payments or default under other
terms of our debt, our lenders will be able to declare all amounts we owe to be
immediately due and payable. If our lenders accelerate our debt, we will not
have funds available to us to pay off the debt. If we cannot repay our secured
debt or if we default under other terms of our debt, our secured lenders could
proceed against any collateral securing that debt. We have been notified by one
of our secured lenders that we are not in compliance with certain covenants of
loans that are secured by a first deed of trust on our headquarters building and
other assets. The lender has, to date, agreed not to exercise its remedies, but
we can offer no assurance that the lender will continue to forebear until we can
regain compliance with those covenants, if at all. The collateral for our
secured debt consists of substantially all of our assets, including receivables,
inventories, real property, personal property, intangible assets, and the stock
of all of our operating subsidiaries. If we are unable to pay our debt or other
obligations, including paying the August 1, 2001 interest payment on our 11 1/4%
senior subordinated notes within the grace period ending on August 31, 2001, we
may be forced to seek protection from creditors under the bankruptcy laws. We
will not be able to make this interest payment before the grace period expires,
and we expect an event of default to occur under those notes. Such an event of
default would also cause events of default under certain of our other debt
instruments, including our 18% senior secured loan. In addition, we may
currently be in default under our 18% senior secured loan for failure to make
the August 1, 2001 interest payment on our 11 1/4% senior subordinated notes. To
date, our secured lenders have not exercised any remedies with respect to any
possible default, but we can provide no assurance that they would not exercise
their remedies as a result of default. We are currently in negotiations with the
holders of approximately 98% of the 11 1/4% senior subordinated notes regarding
a possible restructuring of the Company's debt and equity structure. We do not
currently know whether we will be successful in negotiating a restructuring or
whether such a restructuring would occur inside or outside of bankruptcy.

We do not have revolving lines of credit that would help us fund our operations.

Our U.S. operating line of credit expired on September 5, 2000, and was extended
through March 5, 2001. Due to our continued losses, our U.S. senior lender
decided not to renew our revolving line of credit and we repaid that line of
credit in full on March 2, 2001, out of the proceeds of our 18% senior secured
loan. Our line of credit in the U.K. expired in November 2000. That line of
credit was subsequently extended, and we repaid it in full on March 7, 2001. We
do not plan to request renewal of that line. Our senior secured loan is a term
loan rather than a revolving loan. As a result, if we make payments of principal
before the loan's maturity, additional loan proceeds will not become available,
and the loan will not provide an additional source of cash to fund our
operations or to meet our obligations as they become due.

                                       22
<PAGE>

We have significant debt that adversely affects our financial condition.

At May 31, 2001, our total long-term liabilities were approximately $84.0
million, or approximately 104% of our total assets. At May 31, 2001, we had a
total stockholders' deficit of $25.1 million. Unless we increase our cash flow
from operations, our total stockholders' deficit, coupled with continued losses,
indicates that we will 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, 2001, our balance
sheet includes approximately $5.6 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 have announced our intention to sell our European
Aerospace Group in order to reduce our outstanding debt. We do not yet know
whether we can sell Aeromet or, if it is sold, the amount of net proceeds that
will be available to reduce our debt. In addition to our outstanding 11 1/4%
senior subordinated notes, we have approximately $13.7 million in senior secured
debt that bears interest at 18% per annum. 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.

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 and the loan agreement that relates to our 18%
senior secured 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 historically 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 continue to assimilate our post acquisitions,
and as 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. We

                                       23
<PAGE>

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. We are
currently focusing substantially all of our attention on existing operations.
However, 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 $46.7 million in fiscal
2001, 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 we 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. Based upon estimated net realizable value of certain
assets, we recognized the following impairment charges for the year ended May
31, 2001:

     Within the European Aerospace Group we recognized a $37.0 million charge to
     reduce the $33.0 million carrying value of goodwill and the $13.6 million
     carrying value of manufacturing equipment associated with our European
     Aerospace Group, to the estimated net realizable value of the manufacturing
     equipment, $9.6 million.

     Within the U.S. Aerospace Group, we recognized an impairment charge of $5.5
     million to reduce the $6.4 million carrying value of property and
     manufacturing equipment used at the Entiat, Washington location of the
     group's Casting Division to net realizable value, approximately $0.9
     million. We also recognized a $0.8 million impairment charge to reduce the
     carrying value of the manufacturing equipment located at the Casting
     Division's Tacoma casting location to zero, the estimated net realizable
     value. In addition, we recognized charges of $3.3 million to reduce the
     $3.5 million carrying value of goodwill and manufacturing equipment used in
     the group's Engineering & Fabrication Division to estimated net realizable
     value, $0.2 million.

     Within the U.S. Electronics Group, we recognized a charge of $0.6 million
     to reduce the $1.0 million of manufacturing equipment used to produce low
     power relays to net realizable value, $0.4 million. We also recognized a
     $320,000 charge to reduce the carrying value of an unused manufacturing
     facility of $980,000 to net realizable value, $660,000.

                                       24
<PAGE>

     We also completed an analysis of the estimated future cash flows of certain
     other long-lived assets, including goodwill and patents. Based upon this
     analysis, we recognized additional impairment charges of $1.0 million
     within the U.S. Electronics Group to reduce goodwill to net realizable
     value, and $0.3 million within the U.S. Aerospace Group to reduce patents
     to net realizable value.

The Company will continue to analyze long-lived and identifiable intangible
assets in the future to determine possible impairment charges. Future
evaluations could result in additional impairment charges, and those charges
could be material. At May 31, 2001, the carrying value of long-lived assets,
including property, plant and equipment, goodwill, and patents, was $27.8
million.

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 43% of our assets and approximately 47% 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.

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 47% of our
transactions are conducted in foreign currency, the exchange rate risk could be
material. For the fiscal year ended May 31, 2001, we incurred a foreign currency
translation loss of approximately $2.9 million. 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.

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. As of August 10, 2001, we have reserved 2,295,000 common shares for
issuance under our publicly traded warrants with an exercise price of $4.6875
per share, 3,605,448 common shares for issuance under options outstanding under
our two stock incentive plans with exercise prices ranging from $0.22 to $4.6875
per share, 129,137 common shares for issuance under options outstanding under
our independent director stock plan with exercise prices ranging from $0.9219 to
$1.90 per share, and 5,578,202 common shares for issuance under other warrants
with exercise prices ranging from $0.001 to $9.50 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

                                       25
<PAGE>

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.

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.

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

                                       26
<PAGE>

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.

                                       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 October 2001 and will not be renewed.  Until July
2001, we also leased approximately 873 square feet of office space in Wichita,
Kansas, for a base rent of $928 per month.

The location, use and approximate size of the principal owned and leased
properties where we conduct our operations as of August 10, 2001 are as follows:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
                                              Approx.       Own/          Annual           Lease       Mortgage
    Group                Location               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       Mountlake Terrace,               10,000     Lease            $217,000           2005      N/A
                Washington
---------------------------------------------------------------------------------------------------------------------
                Wenatchee, Washington            41,400     Lease            $166,000           2001      N/A
---------------------------------------------------------------------------------------------------------------------
                Wenatchee, Washington            15,000     Lease            $ 82,000           2002      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>

During the 2001 fiscal year, we also leased properties formerly used by
operations that have been shut down.  These include:

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------
 Group / Division       Location        Approx. Area   Annual Rent      Lease           Sublease
                                           Leased                    Expiration
-------------------------------------------------------------------------------------------------
<S>                 <C>                <C>             <C>           <C>          <C>
U.S. Aerospace      Tacoma, WA                 21,700      $ 80,000         2008  New tenant signed
Casting Division                                                                  lease with
                                                                                  landlord; PA&E
                                                                                  lease terminated as
                                                                                  of August 14, 2001
------------------------------------------------------------------------------------------------------
                    Sedro-Woolley,             94,600      $395,000         2003  Portion subleased
U.S. Aerospace      WA                                                            for $7,679 per
Engineering &                                                                     month until October
 Fabrication                                                                      31, 2001; seeking
 Division                                                                         additional tenants



------------------------------------------------------------------------------------------------------
                    Edmonds, WA                10,800      $155,000         2004  Negotiating lease
                                                                                  termination
------------------------------------------------------------------------------------------------------
                    Everett, WA                11,500      $ 79,000         2003  Subleased for
                                                                                  $5,731 per month,
                                                                                  subject to increase
                                                                                  to $6,250 in April
                                                                                  2002; sublease
                                                                                  expires July 2003
------------------------------------------------------------------------------------------------------
</TABLE>

                                       28
<PAGE>

We are also attempting to sublease the Display Division's facility in Vancouver,
Washington, as a result of the division's move to Wenatchee, Washington that is
currently in progress.

As of December, 2000, we sold a building that we owned in Butler, New Jersey,
where part of our U.S. Electronics Group's Interconnect Division was located
until July 1999.  Net proceeds from the sale of the building was $660,000, and
we recorded a loss of $320,000 on the sale.

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.  In December, 2000, we resold the parcel to the Port of Chelan
County for approximately $930,000.  In July 2001, we executed a Rescission and
Termination Agreement with the Port, which provided for the termination of our
option and the return of a $100,000 deposit.

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

None.

                                       29
<PAGE>

                                    PART II

ITEM 5.          MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

Market Information, Shareholders, and Dividends

Between July 16, 1996 and June 28, 2001, our common stock was traded on the
Nasdaq National Market under the symbol "PCTH", and our public warrants were
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 1999 through May 31, 2001, which covers all of
the calendar quarters within the Company's 2000 and 2001 fiscal years:

<TABLE>
<CAPTION>
                                                             Common Stock                   Warrants
      Calendar Period                                     High           Low           High          Low
      1999
      <S>                                                <C>           <C>            <C>           <C>
      First Quarter                                          2.969          1.688         0.875         0.344
      Second Quarter                                         2.188          1.500         0.594         0.375
      Third Quarter                                          1.781          1.250         0.625         0.250
      Fourth Quarter                                         1.500          0.594         0.688         0.188
      2000
      First Quarter                                          7.000          1.125         2.438         0.250
      Second Quarter                                         3.000          1.188         1.313         0.406
      Third Quarter                                          2.656          0.781         1.063         0.250
      Fourth Quarter                                         1.438          0.313         0.563         0.094
      2001
      First Quarter                                          0.906          0.219         0.313         0.094
      Second Quarter (April 1-May 31, 2001)                  0.313          0.180         0.160         0.080
</TABLE>

On June 28, 2001, our securities were delisted from the Nasdaq National Market
and are currently traded on the OTC Bulletin Board.

As of August 10, 2001, the closing sales price of our common stock on the OTC
Bulletin Board was $0.12 per share, and the closing sales price of our warrants
was $0.01.

We have never declared or paid cash dividends on our common stock.  We currently
anticipate that we will retain any 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 senior secured lenders and the indenture
governing our 11 1/4% senior subordinated notes restrict our ability to pay
dividends.

Common Stock

As of August 10, 2001, there were 1,078 holders of record of 39,315,309 shares
of common stock outstanding, and 21 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

                                       30
<PAGE>

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 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.  The Company does not
currently have any preferred stock outstanding.

Warrants

As of August 10, 2001, we had outstanding exercisable warrants to purchase
common stock as follows:

    .       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 a total of 1,156,224 shares of common stock
            issued to several employees and consultants of the Company, that (a)
            have exercise prices ranging from $0.4062 to $9.50 per share, and
            (b) have expiration dates that range from May 2002 to April 2006;

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

    .       warrants to purchase 4,036,978 shares of common stock that (a) were
            issued in connection with a private placement in March 2001, (b)
            have an exercise price of $.001 per share, and (c) expire in March
            2006. See "--March 2001 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.

                                       31
<PAGE>

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.  As of June 26, 2000, all of these shares
had been converted into a total of 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. 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 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 to purchase 236,109
shares of common stock at an exercise price of $7.20 per share that were issued
in connection with the Preferred Stock expired on May 15, 2001.

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 $1,713,000, 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 an 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.  This condition was not satisfied,
and the investors decided not to waive the condition.  As a result, the second
closing did 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.

Adjustable Warrants.  On July 27, 2000, we issued to the investors adjustable
warrants, which permitted the investors to acquire additional shares of common
stock at an exercise price of $.001 per share if the market price of our common
stock did not achieve and maintain a specific price during each

                                       32
<PAGE>

of three vesting periods. On February 15, 2001, Pacific Aerospace and the
investors agreed to amend the adjustable warrants to provide that each of the
two investors, upon exercise in full of its adjustable warrant, would be
entitled to purchase 2,095,243 shares of common stock.

The fixed number of shares specified in the amendment was negotiated to replace
the provisions of the adjustable warrants that would have determined the number
of shares issuable under those warrants based on a formula that depended on the
market price of our common stock during three vesting periods. The vesting
periods would have been the 20 consecutive trading days before the 20/th/,
40/th/, and 60/th/ trading days after the effective date of the registration
statement covering the shares issued to the investors on July 27, 2000. That
registration statement became effective on January 31, 2001. The closing price
of our common stock on February 15, 2001, the date of the amendment, was $.4063
per share. If the adjustable warrants had not been amended and our common stock
price had been $.4063 throughout the three vesting periods, a total of 4,207,666
shares would have been issuable under the adjustable warrants.

On February 15, 2001, the investors exercised the adjustable warrants in full,
as so amended, for the exercise price of $.001 per share. The exercise price was
not changed by the amendment described above. As a result of the exercise, we
delivered to the investors a total of 4,190,486 shares of common stock. The
resale of these shares was covered by a registration statement on Form S-3 (File
No. 333-56884) filed on March 12, 2001.

Vesting Warrants.  We also issued vesting warrants to the investors on July 27,
2000.  The purpose of the vesting warrants was to give Pacific Aerospace an
incentive not to cause any triggering events to occur prior to expiration of the
vesting warrants and an incentive to cure triggering events that occurred, if
they could be cured.  On February 15, 2001, Pacific Aerospace and the investors
agreed that the vesting warrants would expire on the fifth business day after we
delivered the shares issuable upon exercise of the adjustable warrants.  We
delivered the shares on February 21, 2001, and the vesting warrants expired on
February 28, 2001.

Closing Warrants. On July 27, 2000, we also issued the investors in the private
placement closing warrants to purchase an aggregate of 385,000 shares of common
stock at an exercise price of $2.01 per share. The February 15, 2001 amendment
did not amend the terms of the closing warrants. 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 our common
stock price exceeds $2.01 per share prior to expiration of the warrants. The
resale of the shares issuable upon exercise of the Closing Warrants was
registered on a registration statement on Form S-3 (File No. 333-44686), filed
on August 28, 2000.

March 2001 Private Placement

On March 1, 2001, we borrowed approximately $13.8 million from four lenders: B
III Capital Partners, L.P., B III-A Capital Partners, L.P., DDJ Canadian High
Yield Fund and State Street Bank & Trust, as Custodian for General Motors
Employees Global Group Pension Trust. In connection with the secured loan, we
issued warrants to purchase an aggregate of 4,036,978 shares of common stock
with an exercise price of $.001 per share to the four lenders as an incentive
for them to make the loan. The warrants are exercisable through March 1, 2006
and contain weighted average anti-dilution

                                       33
<PAGE>

protection in the event we issue equity securities at a price less than market
price determined in the manner set forth in the Warrant Agreement. The lenders
may exercise the warrants at any time for the exercise price of $.001 per share,
whereupon they will receive up to an aggregate amount of 4,036,978 shares of
common stock of the Company. DDJ Capital Management, LLC, serves as the
investment advisor to each such entity and, accordingly, may be deemed the
beneficial owner of the shares of common stock underlying the warrants received
by the lenders. The terms of the transaction, including the terms of the
warrants, were determined by arms length negotiations between Pacific Aerospace
and the lenders. We used approximately $9.5 million of the loan to repay our
revolving line of credit in the U.S. and to pay the interest payment on our 11
1/4% senior subordinated notes that was due on February 1, 2001. The remainder
of the proceeds were used to replace our line of credit in the United Kingdom,
to pay costs of the secured loan transaction and to provide working capital. The
transaction documents also provided that we would file a registration statement
registering the shares of common stock underlying the warrants issued to the
lenders within 30 days following the closing of the loan. We filed a
registration statement on Form S-3 (File No. 333-58148) on April 2, 2001.

We also paid a commission of approximately $415,000 to First Albany Corporation,
the placement agent that represented us in the transaction, and issued warrants
to purchase up to 692,074 shares of our common stock to the placement agent, at
an exercise price of $.4062 per share.  The placement agent warrants are
exercisable at any time through April 9, 2006.  The placement agent warrants
were issued pursuant to the exemption from registration contained in Rule 506 of
Regulation D under the Securities Act, and neither the warrants nor the shares
issuable upon exercise of the warrants may be resold unless registered or exempt
from registration under the securities laws.  The placement agent has piggy-back
registration rights with respect to the shares issuable upon exercise of the
warrants.

Registration Rights

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

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.

We are 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.

We are obligated to register for resale up to 692,074 shares issuable upon
exercise of warrants held by the placement agent in our March 2001 private
placement.

Nasdaq

Until June 28, 2001, our common stock was quoted on the Nasdaq National Market.
In order to remain listed on this market, we were required to meet Nasdaq's
listing maintenance standards.  On March 22, 2001, we received a determination
letter from Nasdaq staff indicating that, absent a successful appeal by the
Company, our securities would be delisted for failure to comply with Marketplace
Rule 4450(a)(5), which requires listed stock to maintain a minimum bid price of
$1.00.  Our common stock had traded below $1.00 since November 7, 2000.
Subsequent to the notice, we notified Nasdaq that we also failed to comply with
Marketplace Rule 4450(a)(3), which requires an issuer of listed securities to
maintain net tangible assets of at least $4 million.  We appealed the Nasdaq
staff determination before a Nasdaq qualification hearings panel on May 11,
2001, but we were notified

                                       34
<PAGE>

on June 27, 2001 that our securities would be delisted on June 28, 2001, and the
delisting occurred on that date. Our common stock and public warrants are
currently traded on the OTC Bulletin Board.

Indemnification

The Company agreed to indemnify the holders of the Preferred Stock, the
investors in the Summer 2000 private placement, and the holders of the warrants
issued in the March 2001 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.

                                       35
<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, 1997, 1998, 1999, 2000
and 2001, 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. The independent auditors' report for the
fiscal year 2001 is a disclaimer of opinion. 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)
                                                          1997           1998           1999            2000           2001
                                                      ------------   ------------    ----------      ----------     ----------
<S>                                                   <C>            <C>             <C>             <C>            <C>
Statement of Operations Data:
  Net sales/(1)/...............................       $   34,175     $   54,099      $ 107,366       $ 112,694      $ 109,288

  Cost of sales................................           25,969         39,487         86,302          92,063        101,048
                                                      ------------   ------------    ----------      ----------     ----------
  Gross profit.................................            8,206         14,612         21,064          20,631          8,240
  Operating expenses...........................            6,259          9,872         22,039          24,533         67,201
                                                      ------------   ------------    ----------      ----------     ----------
  Income (loss) from operations................            1,947          4,740           (975)         (3,902)       (58,961)
  Net interest (expense).......................             (384)          (755)        (8,140)         (9,862)       (10,012)
  Other income (expense).......................              169           (853)        (6,393)             33            201
                                                      ------------   ------------    ----------      ----------     ----------
  Income (loss) before taxes and
   extraordinary item..........................            1,732          3,132        (15,508)        (13,731)       (68,772)
  Extraordinary item, net of tax...............                -              -              -             703              -
  Income taxes benefit (expense)...............              (50)           482          2,639             (21)        (6,948)
                                                      ------------   ------------    ----------      ----------     ----------
  Net income (loss)............................       $    1,682     $    3,614      $ (12,869)      $ (13,049)     $ (75,720)
                                                      ========================================================================
  Net income (loss) per share:
   Basic.......................................              .18            .29           (.74)           (.59)         (2.15)
   Diluted.....................................              .17            .27           (.74)           (.59)         (2.15)
  Shares used in computation of
   income (loss) per share:
   Basic.......................................            9,500         12,486         17,359          21,955         35,283
   Diluted.....................................           10,036         13,606         17,359          21,955         35,283
Other Financial Data:
  Adjusted EBITDA/(2)/.........................       $    3,305     $    6,944      $  10,669       $   9,004      $  (2,681)
  Adjusted EBITDA margin/(3)/..................              9.7%          12.8%           9.9%            8.0%          (2.5)%
  Depreciation, amortization, and                     $    1,358     $    2,204      $  11,644       $  12,906      $  56,280
   impairment of long-lived assets.............
  Capital expenditures.........................            2,739         10,290          8,281           4,867          3,710
</TABLE>

                                       36
<PAGE>

<TABLE>
<CAPTION>
                                                                                     At May 31,
                                                      ------------------------------------------------------------------------
                                                                                   (in thousands)
                                                          1997           1998           1999            2000           2001
                                                      ------------   ------------    ----------      ----------     ----------
<S>                                                   <C>            <C>             <C>             <C>            <C>
Balance Sheet Data:
  Cash and cash equivalents...........                $      3,048   $     11,461    $    8,134      $    2,154     $    4,095
  Working capital.....................                      13,090         25,599        38,329          29,181         25,034
  Total assets........................                      35,752         78,580       158,727         143,582         80,816
  Long-term debt (including current
   portion)...........................                       4,233         11,233        83,410          70,528         82,932

  Shareholders' equity (deficit)......                      25,619         56,142        54,019          49,768        (25,114)
</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 our operating performance or (ii) cash flow, as defined by
       generally accepted accounting principles, as a measure of liquidity. We
       report Adjusted EBITDA because it is a cash flow capacity measure
       commonly used by financial institutions, including holders of our senior
       subordinated notes. Generally, we consider 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.

                                       37
<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
--------

Pacific Aerospace & Electronics, Inc., is an 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,
energy and medical industries include components such as hermetically sealed
electrical connectors and instrument packages and ceramic capacitors, filters
and feed-throughs.  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.

For our fiscal year ended May 31, 2001, we had net sales of approximately $109
million, with the European Aerospace Group contributing approximately $52
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, 2001, we had approximately $64 million in
principal amount of 11 1/4% senior subordinated notes outstanding.  Because we
are in 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 or our approximately $13.7 million of 18%
senior secured notes. We are required to pay our senior secured lenders at least
$7.5 million upon the sale of our European Aerospace Group. Although at this
time we have not committed to the sale of the group, we have received several
bona-fide preliminary and final offers to purchase the group. If these offers
approximate the final negotiated sales price for the group and we commit to the
sale of the group, the offers indicate that we will incur an impairment loss
related to goodwill and equipment of approximately $37 million. Consequently, we
recorded an impairment loss related to our European Aerospace Group goodwill of
$25 million for the quarter ended February 28, 2001, and an additional
impairment loss of $12 million related to goodwill and equipment for the quarter
ended May 31, 2001. We have also reviewed all other long-lived assets and have
recorded impairment losses of approximately $1.0 million, $7.4 million and $3.4
million during the quarters ended November 30, 2000, February 28, 2001 and May
31, 2001, respectively.

On March 30, 2001, we announced that we put in place a plan to restructure our
operations. In connection with the plan, our European Aerospace Group has been
placed for sale, and we closed an unprofitable foundry in Tacoma, Washington. We
have also downsized our U.S. Aerospace Group's Engineering & Fabrication
Division by closing our fabrication facilities in Sedro-Woolley, Washington and
we have sold substantially all of the assets related to the fabrication
business. On June 1, 2001, subsequent to our fiscal year end, we completed the
sale of substantially all of the assets of our U.S. Aerospace Group's Casting
operation located in Entiat, Washington. We believe that these asset sales

                                       38
<PAGE>

and closures or sales of business units will help to strengthen and support our
core electronics, engineering and aerospace machining operations.

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,
                                             ------------------------------------------------------------------
                                                     1997                     1998                  1999
                                             -------------------        ---------------      ------------------
<S>                                          <C>           <C>          <C>       <C>        <C>          <C>
Net sales                                    $ 34,175      100.0 %      54,099    100.0      $ 107,366    100.0 %
Cost of sales                                  25,969       76.0        39,487     73.0         86,302     80.4
                                             -------------------        ---------------      ------------------
Gross profit                                    8,206       24.0        14,612     27,0         21,064     19.6
Operating expenses                              6,259       18.3         9,872     18.2         22,039     20.5
                                             -------------------        ---------------      ------------------
Income (loss) from operations                   1,947        5.7         4,740      8.8           (975)    (0.9)
Net interest expense                             (384)      (1.1)         (755)    (1.4)        (8,140)    (7.6)
Other income (expense)                            169        0.5          (853)    (1.6)        (6,393)    (6.0)
Extraordinary item                                  -          -             -        -              -        -
Income tax benefit (expense)                      (50)      (0.1)          482      0.9          2,639      2.5
                                             -------------------        ---------------      ------------------
Net income (loss)                            $  1,682        4.9 %       3,614      6.7      $ (12,869)    12.0 %
                                             ===================        ===============      ==================
 Adjusted EBITDA/(1)/                        $  3,305        9.7 %       6,944     12.8      $  10,669      9.9 %
                                             ===================        ===============      ==================

<CAPTION>
                                              -------------------          ----------------------
                                                      2000                          2001
                                              -------------------          ----------------------
<S>                                           <C>           <C>            <C>              <C>
Net sales                                     $ 112,694     100.0 %        $ 109,288        100.0 %
Cost of sales                                    92,063      81.7            101,048         92.5
                                              -------------------          ----------------------
Gross profit                                     20,631      18.3             8,240           7.5
Operating expenses                               24,533      21.8            67,201          61.5
                                              -------------------          ----------------------
Income (loss) from operations                    (3,902)     (3.5)          (58,961)        (54.0)
Net interest expense                             (9,862)     (8.8)          (10,012)         (9.2)
Other income (expense)                               33         -               201           0.2
Extraordinary item                                  703       0.6                 -             -
Income tax benefit (expense)                        (21)        -            (6,948)         (6.3
                                              -------------------          ----------------------
Net income (loss)                             $ (13,049)    (11.6)%        $(75,720)        (69.3)%
                                              ===================          ======================
 Adjusted EBITDA/(1)/                         $   9,004       8.0 %        $ (2,681)         (2.5)%
                                              ===================          ======================
</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 our operating
performance or (ii) cash flow, as defined by generally accepted accounting
principles, as a measure of liquidity. We report Adjusted EBITDA because it is a
cash flow capacity measure commonly used by financial institutions, including
holders of our senior subordinated notes. Generally, we consider 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, 2001 Compared to Year Ended May 31, 2000

Net Sales.  Net sales decreased by $3.4 million, or 3.0%, to $109.3 million for
fiscal 2001 from $112.7 million in fiscal 2000.  The European Aerospace Group
contributed $51.6 million, down $5.3 million from the $56.9 million contributed
during the year ended May 31, 2000.  Our customers in the European aerospace
market have been initiating lean manufacturing methods and just-in-time
inventory delivery requirements similar to those previously initiated by our
customers in the U.S. aerospace market.  These initiatives resulted in decreased
orders for our European Aerospace Group.  The European Aerospace Group is
currently being offered for sale, although we have not committed to a formal
plan of disposition.  If the sale of European Aerospace Group is completed the
net sales from this group will be substantially reduced during fiscal 2002 from
fiscal 2001.  If the sale is not completed, we expect this group's net sales
volumes to remain flat or decrease slightly and for order backlog to decrease
accordingly during fiscal 2002.  The lowering of the exchange rate of the
British pound sterling versus the U.S. dollar also contributed to lower net
sales volumes from the European Aerospace Group during fiscal 2001 and may
continue to do so during fiscal 2002. Had the average exchange rate for fiscal
2001 been equal to the average exchange rate for fiscal 2000, reported net sales
for our European Aerospace Group would have been approximately $56.0 million, or
$4.4 million higher than actual.  The U.S. Aerospace Group contributed $29.1
million during the year ended

                                       39
<PAGE>

May 31, 2001, down $2.4 million from the $31.5 million contributed during the
year ended May 31, 2000. The U.S. Aerospace Group's casting businesses
experienced an unanticipated revenue decline ($3.7 million) during the year, due
in large part to lower demand for heavy trucking products, which we believe was
primarily a result of higher fuel costs and a cyclical downturn in the heavy
trucking segment of the transportation market. This decrease in revenue was
offset partially by increased revenue ($1.3 million) from telecommunications
companies in our machining business. During fiscal 2001, we transitioned
machining of telecommunications parts out of the U.S. Aerospace Group into the
U.S. Electronics Group in order to process the orders more efficiently. However,
due to the recent downturn in the telecommunications market, our orders for
machined telecommunications parts have been cancelled or deferred by our
customers. We believe that the demand for machined telecommunications parts
should return late in our fiscal year 2002, but we do not expect this to have a
significant impact on net sales during fiscal 2002. As of June 1, 2001, we
completed the sale of substantially all of the assets of the U.S. Aerospace
Group's Casting Division. We have also downsized and sold substantially all of
the assets of the fabrication portion of the U.S. Aerospace Group's Engineering
& Fabrication Division. Because of those sales and downsizing, we expect that
net sales contributed by our U.S. Aerospace Group will be substantially lower in
fiscal 2002 than in fiscal 2001. Our U.S. Electronics Group contributed $28.6
million to net sales during the year ended May 31, 2001, up $4.3 million from
the $24.3 million contributed during the year ended May 31, 2000. This increase
was attributable to additional sales by our U.S. Electronics Group's Filter
Division ($0.5 million) of products for telecommunications systems, and sales of
non-ruggedized flat panel displays by our U.S. Electronics Group's Display
Division ($2.2 million). Our U.S. Electronics Group's Interconnect Division also
increased net sales revenue ($1.6 million) related to our core sealing and
materials technologies applied to electronic packaging. We currently expect the
sales volume in our U.S. Electronics Group to increase during fiscal year 2002.

Receivable collection periods, as calculated by dividing ending accounts
receivable balances by sales for the year multiplied by 360 days, decreased to
62.9 days for the year ended May 31, 2001 from 67.8 days for the year ended May
31, 2000. This decrease was due to a concerted effort by operations management
to increase collection efforts.

Gross Profit. Gross profit decreased by $12.4 million, or 60.0%, to $8.2 million
for the year ended May 31, 2001, from $20.6 million for the year ended May 31,
2000. As a percentage of net sales, gross profit decreased to 7.5% for the year
ended May 31, 2001, from 18.3% for the year ended May 31, 2000. The most
significant gross margin decrease occurred in our U.S. Aerospace Group, which
continues to under perform due to the lingering effects on our business of the
downturn in the commercial aerospace industry and the drawn out cyclical
downturn in the heavy trucking transportation industries. Gross margins for the
U.S. Aerospace Group decreased from 6.7% during the year ended May 31, 2000 to
negative 21.6% during the year ended May 31, 2001. Effective June 1, 2001, we
completed the sale of substantially all of the assets of the U.S. Aerospace
Group's Casting Division. We have also downsized and sold substantially all of
the assets of the fabrication portion of the U.S. Aerospace Group's Engineering
& Fabrication Division. We believe that these sales and downsizing should allow
our U.S. Aerospace Group to realize positive gross margins in fiscal 2002 if
current economic trends do not worsen. Gross margins decreased in our European
Aerospace Group from 13.5% for the year ended May 31, 2000 to 11.1% for year
ended May 31, 2001. This decrease was primarily due to pricing pressure from
customers. We currently expect the gross margins for the European Aerospace
Group to increase during fiscal 2002 due to lean manufacturing initiatives and
cost containment measures. Gross margins decreased in our U.S. Electronics Group
from 44.8% for the year ended May 31, 2000 to 30.8% for the year ended May 31,
2001. This decrease was due to a different product mix within the group,
primarily an increased number of non-ruggedized flat panel

                                       40
<PAGE>

displays, low power relays, and telecommunications parts, which had the effect
of lowering overall gross margins in this group. We also had a $1.6 million
inventory charge during the year related to the termination of a contract in our
U.S. Electronic Group's Display Division. Without this charge, gross margins
would have been 36.4%. We currently expect gross margins to increase within the
U.S. Electronics Group during fiscal year 2002. Overall, we currently expect
consolidated gross margins to increase during fiscal year 2002.

Inventory turnover, as calculated by dividing sales for the year by ending
inventory, increased to 4.7 turns for the year ended May 31, 2001 from 4.0 turns
for the year ended May 31, 2000.  The increase was due to lower inventory
levels.  We currently expect that our inventory turns will continue to increase
during fiscal year 2002.

Operating Expenses.  Operating expenses increased by $42.7 million, to $67.2
million for the year ended May 31, 2001 from  $24.5 million for the year ended
May 31, 2000.  The increase in operating expenses is primarily attributable to
non-cash impairment charges totaling approximately $48.9 million.  We review
long-lived assets and identifiable intangibles for potential impairment of value
whenever events or circumstances indicate that the carrying amount of those
assets may not be recoverable.  Based upon preliminary and final offers to
purchase our European Aerospace Group, we recognized a $37.0 million charge to
reduce the $33.0 million carrying value of goodwill and the $13.6 million
carrying value of equipment associated with our European Aerospace Group, to net
estimated realizable value, approximately $9.6 million.  We are still in the
process of selling the European Aerospace Group and hope to have the sale
finalized during our first or second quarter of fiscal year 2002.  We also
recognized an impairment charge of $5.5 million to reduce the $6.4 million
carrying value of property and equipment used at the Entiat, Washington location
of our U.S. Aerospace Group's Casting Division to net realizable value,
approximately $0.9 million. During the year ended May 31, 2001, we closed a
facility located in Tacoma, Washington that was used by our U.S. Aerospace
Group's Casting Division.  We recognized a $0.8 million impairment charge to
reduce the carrying value of the equipment located at the Tacoma location to
zero, the estimated net realizable value. Also, included in operating expenses
are non-cash charges of approximately $3.3 million to reduce the $3.5 million
carrying value of goodwill and equipment used in the U.S. Aerospace Group's
Engineering & Fabrication Division to estimated liquidation value, approximately
$0.2 million.  We completed the sale of substantially all of the assets used in
the fabrication portion of the Engineering & Fabrication Division during the
fourth quarter of fiscal year 2001.  Within the U.S. Electronic Group's Display
Division, we recognized a non-cash charge of approximately $0.6 million to
reduce the $1.0 million of equipment used to produce low power relays to its net
realizable value, approximately $0.4 million.  The equipment, inventory, and
intellectual property used to produce low power relays were sold during the
fourth quarter of fiscal year 2001. Gross proceeds from the sale were $400,000
compared to a carrying amount of approximately $1.0 million.  Operating expenses
also include an approximately $320,000 non-cash charge for the loss on the sale
of an unused building in Butler, New Jersey that was sold during December 2000.
Net proceeds from the sale of the building were approximately $660,000, versus a
carrying amount of approximately $980,000.  During the fourth quarter of fiscal
2001 we completed our analysis of the value of certain other long-lived assets,
including goodwill and patents.  Based upon this analysis, we recognized
additional impairment charges of approximately $1.0 million to reduce goodwill
to estimated fair value, and approximately $0.3 million to reduce patents to
estimated fair value.  We will continue to analyze long-lived and identifiable
intangible assets at the end of each future quarter to determine possible
impairment charges.  Although we do not believe it likely, our future
evaluations could result in additional impairment charges and those charges
could be material.  At May 31, 2001, the reported value of long-lived assets,
including property, plant and equipment, goodwill, and patents, was $27.8
million.

                                       41
<PAGE>

Without impairment charges during the respective years, operating expenses
decreased by $0.9 million to $18.3 million for the year ended May 31, 2001 from
$19.2 million for the year ended May 31, 2000.  This decrease in operating
expenses relates primarily to our cost reduction efforts.

Net Interest Expense.   Net interest expense increased $0.1 million to $10.0
million for the year ended May 31, 2001 from $9.9 million for the year ended May
31, 2000.  This increase was primarily due to higher average line of credit
balances for the first three quarters of the year plus the addition of our 18%
senior secured notes and related loan costs during the fourth quarter of the
year.  The increase in interest from the above items was offset by lower average
outstanding balance on our 11 1/4% senior subordinated notes during the year.
If our total outstanding senior secured and senior subordinated note balances do
not decrease during fiscal year 2002, our interest expense for fiscal year 2002
will be substantially higher than the expense for fiscal year 2001.

Other Income (Expense).  Other income (expense) represents non-recurring and
non-operational income and expense for the period. Other income increased to
$201,000 for the year ended May 31, 2001 from $33,000 for the year ended May 31,
2000. Other income in the current year primarily represents rental income and
gain on the sale of certain assets.

Provision for Income Taxes.  Income taxes for the year ended May 31, 2001
primarily represent charges to write off deferred tax assets, $4.9 million, to
adjust deferred income tax assets to amounts determined more likely than not to
be realizable in accordance with the guidelines set forth in FAS 109, Accounting
for Income Taxes.   In addition, due to a tax assessment in the U.K. related to
interest remitted to Pacific Aerospace, a foreign parent, tax expense also
includes an accrual of approximately $1.7 million.   We expect income tax
expense in future periods to be minimal.

Net loss.   Net loss increased $62.7 million, to a net loss of $75.7 million for
the year ended May 31, 2001 from a net loss of $13.0 million for the year ended
May 31, 2000, primarily as a result of the factors discussed above.

Adjusted EBITDA.   Adjusted EBITDA decreased by $11.7 million to negative $2.7
million for the year ended May 31, 2001 from $9.0 million for the year ended May
31, 2000.  The decrease in adjusted EBITDA was due primarily to negative
adjusted EBITDA generated by the U.S. Aerospace Group, primarily the Engineering
& Fabrication Division and the Casting Division.  We have downsized and sold
substantially all of the assets related to our Casting Division and the
fabrication portion of the Engineering & Fabrication Division.  Because of these
sales and downsizing, we currently believe that adjusted EBITDA should improve
during fiscal year 2002.

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
$4.0 million increase) and the addition of our Engineering & Fabrication
Division ( a $6.7 million increase), offset by reduced sales volume in our
Machining Division ( a $7.1 million decrease).  The Machining Division continues
to be affected by decreases in production of certain aircraft models and
inventory minimization initiatives at Boeing, the division's largest customer.

                                       42
<PAGE>

Gross Profit.  Our gross profit 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 lead to low overall gross profit in the aerospace and
transportation markets.

Operating Expenses.  Operating expenses increased $2.5 million, or 11.4%, 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 Engineering & Fabrication
division.  Operating expenses include non-cash charges related to the impairment
of long-lived assets, primarily goodwill, of $5.3 million in fiscal 2000 and
$4.7 million 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 assets in our U.S. Aerospace
Group on a quarterly basis until such time as the divisions in that group become
consistently profitable.  Our future evaluations could result in additional
impairment charges for goodwill, property, and equipment values as well as
carrying values of inventories.

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

Net Interest Expense.   Net interest expense increased $1.7 million, or 21.0%,
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

                                       43
<PAGE>

expense associated with our 11 1/4% senior subordinated debt, and higher average
outstanding balances on our revolving lines of credit.

Other Income (Expense).   Other income (expense) represents non-recurring and
non-operational income and expense for the period.  Other expense decreased $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 the shares of Orca
Technologies, Inc. common stock.

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 $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.

Adjusted EBITDA.  Adjusted EBITDA decreased by $1.7, 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 the decreased gross profit due to the
decline in commercial aerospace and transportation net sales.

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 our European Aerospace Group (a $52.8 million increase),
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 acquisition of our European Aerospace Group 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.
Accordingly, net sales for fiscal 1999 also included ten months of operations of
our European Aerospace Group, 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 our European Aerospace Group 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 our European Aerospace
Group's 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 adjustments to inventories, which reduced gross profits 2.1% for
fiscal 1999.

Operating Expenses. Operating expenses increased by $12.1 million, or 122.2%, to
$22.0 million for fiscal 1999 from $9.9 million in fiscal 1998. The acquisition
of our European Aerospace Group added
                                       44
<PAGE>

$2.7 million, corporate operational costs added $2.5 million, $2.2 million was
attributable to general cost increases in operating businesses, and $4.7 million
was due to non-cash impairment of long-lived assets, primarily goodwill.

Net Interest Expense.   Net interest expense increased $7.4 million, or 980%, 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 of our European
Aerospace Group 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 non-recurring 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
shares of Orca Technologies, Inc. common stock.

Net Income.   Net income decreased $16.5 million, to a $12.9 million loss for
fiscal 1999 from a $3.6 million profit in 1998, primarily as a result of the
factors discussed above.

Adjusted EBITDA.   Adjusted EBITDA increased by $3.7, 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 adjustments to inventories recorded
during the year and the decreased gross profit due to the decline in commercial
aerospace net sales.

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

Cash used in operating activities was $1.6 million for the year ended May 31,
2001, compared to cash used in operating activities of $5.2 million for the year
ended May 31, 2000.  The change in cash used in operating activities was
primarily a result of decreasing accounts receivable and inventory balances and
increasing accounts payable and accrued liability balances.  Our success as a
company will depend heavily on our ability to generate cash from operating
activities in the future.  We can offer no assurance that we will achieve
profitable operations or that any profitable operations will be sustained.  We
are continuing to focus on initiatives that specifically address the need to
increase cash provided by operating activities.  Some of these initiatives have
been completed, such as the closure of our Sedro-Woolley fabrication operations
and the sale of our U.S. casting operations, both of which provided negative
cash flow from operating activities.  Other initiatives include, but are not
limited to, staff reductions, selling of excess inventory, and general and
administrative cost controls.  We continue to reduce staffing at our operating
units to better match revenue levels, and we have significantly reduced staff at
our corporate headquarters to reduce indirect overhead costs.  We are attempting
to sublease all or portions of unused facility space.  If we are not successful
in increasing cash provided by operating activities, we may need to sell
additional common stock or other securities, or we may need to 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 sell additional equity securities
or that we will be able to sell assets outside the ordinary course of business
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
as a going concern.

Our existing cash and credit facilities will not be sufficient to meet our
obligations as they become due.  Consequently, we will need to obtain additional
cash.  Our actual cash needs will depend primarily on

                                       45
<PAGE>

the amount of cash generated from or used by operations and financing
activities. We cannot predict accurately the amount or timing of our future cash
needs. We did not make a semi-annual interest payment of approximately $3.6
million on our 11 1/4% senior subordinated note that was due on August 1, 2001,
and we will not be able to make that payment before expiration of the 30-day
grace period that expires on August 31, 2001. As a result, we expect an event of
default to occur under those notes. Such an event of default would also cause
events of default under certain of our other debt instruments, including our 18%
senior secured loan. In addition, we may currently be in default under our 18%
senior secured loan for failure to make the August 1, 2001 interest payment on
our 11 1/4% senior subordinated notes. To date, our secured lenders have not
exercised any remedies with respect to any possible default, but we can provide
no assurance that they would not exercise their remedies as a result of any
default. Possible remedies include acceleration of the due dates of our debt. We
are currently in negotiations with the holders of approximately 98% of our 11
1/4% senior subordinated notes regarding a possible restructuring of the
Company's debt and equity structure. We did not make our February 1, 2001
interest payment on those notes until March 2, 2001, which was one day before
expiration of the 30-day grace period. We made the interest payment from the
proceeds of an approximately $13.8 million senior secured loan that closed on
March 1, 2001. The March 1, 2001 loan bears interest at 18% per annum, payable
quarterly. To date, we have made interest payments on the 18% senior secured
loan on time. We have the option to defer and accrue a portion of the quarterly
interest payments, up to 1 1/4% per quarter, for up to a year at the time of any
interest payment. We exercised this right for our interest payments made in
March and June 2001. We do not currently have sufficient cash to make the
September 30, 2001 interest payment on our 18% senior secured loan, and we will
need to raise additional cash to make that payment. We have been notified by one
of our secured lenders that we are not in compliance with certain covenants of
loans that are secured by a deed of trust on our headquarters building and other
assets. The lender has, to date, agreed not to exercise its remedies, but we can
offer no assurance that the lender will continue to forbear until we can regain
compliance with those covenants, if at all. We need to raise additional cash to
make future payments on our debt and to fund our operations. If we are unable to
obtain sufficient cash when needed to fund our operations, to make our loan
payments, and to pay our other obligations when due, we may be forced to seek
protection from creditors under the bankruptcy laws.

Cash used in investing activities decreased from $7.7 million for the year ended
May 31, 2000 to $1.5 million during the year ended May 31, 2001.  In fiscal year
2001 we made cash investments for the acquisition of equipment of $3.7 million
offset by $2.3 million of cash from the sale of assets, primarily an unused
building and unused vacant land.  We expect to reduce the amount of capital
expenditures in fiscal year 2002 and we do not expect to acquire any new
businesses during fiscal year 2002.

Cash generated from financing activities decreased from $6.8 million during the
year ended May 31, 2000 to $5.3 million during the year ended May 31, 2001.
Financing activities during fiscal 2001 included net proceeds from the issuance
of common stock and warrants, $1.9 million, and borrowing under our 18% senior
secured notes of approximately $13.8 million.  Approximately, $9.3 million of
the 18% senior secured notes was used to directly refinance certain short-term
obligations, including our bank line of credit and accrued interest on our 11
1/4% senior subordinated notes.

At May 31, 2000, our primary banking relationships included a revolving line of
credit of up to $6.3 million in the U.S. and a revolving line of credit of up to
approximately $5.0 million ((Pounds)3.5 million) in the U.K.  Both of these
credit facilities have been replaced with a senior secured term loan of $13.8
million from four institutional lenders.  The loan bears interest at 18% per
annum, payable quarterly, and has a two-year term.  We have the right to defer
and accrue a portion of the interest on the loan, up to 1 1/4% per quarter, for
up to a year at the time of any interest payment.  The loan is secured by our

                                       46
<PAGE>

assets, the assets of our United States subsidiaries, and other intangibles.
This senior secured loan is a term loan rather than a revolving loan.  As a
result, if we make payments of principal before the loan's maturity, additional
loan proceeds will not become available, and the loan will not provide an
additional source of cash to fund our operations or to meet our obligations as
they become due.

Our working capital as of May 31, 2001 and May 31, 2000 was $25.0 million and
$29.2 million, respectively.    The decrease in working capital was primarily
caused by continued losses, increasing accounts payable and accrued liability
balances, and decreasing accounts receivable and inventory balances.  The
working capital decrease was partially offset by the refinancing of certain
short-term obligations, our line of credit, and accrued interest on our 11 1/4%
senior subordinated notes, with our 18% senior secured loan, which is long-term
debt.  If we are not able to increase our cash from operations, increase net
income, and secure additional long-term financing or sell additional equity, our
working capital will decline during fiscal year 2002.

Our consolidated financial statements have been prepared assuming that we will
continue as a going concern.  However, our independent auditors in their report
accompanying our audited consolidated financial statements stated that we have
suffered recurring losses from operations which raise substantial doubt about
our ability to continue as a going concern.  The independent auditors' report
for fiscal year 2001 is a disclaimer of opinion.  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 value of
those assets upon liquidation.  If we are unable to generate the necessary cash,
we could be unable to continue operations.

The functional currency of our European Aerospace Group 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 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 the year ended May 31,
2001, the foreign currency translation adjustment was negative $2.9 million.  We
have not entered into any hedging activity as of May 31, 2001.

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

Equity Financing - Sale of Common Stock

In July 2000, we closed the first of two proposed installments of a $3.5 million
private placement of common stock to two accredited investors.  On that date, we
issued 1,142,860 shares of common stock and certain adjustable, vesting, and
closing warrants to purchase additional shares 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 to register the resale of the shares of
common stock issued at closing and issuable upon exercise of closing warrants
(the "Registration Statement").  If the Registration Statement had become
effective within 60 days after the first closing a second closing would have
occurred and the investors would have paid an additional $1.5 million and
received 857,140 additional shares of common stock.  However, the Registration
Statement did not become effective within 60 days of the first closing and
consequently the second installment did not close.  The adjustable warrants
permitted

                                       47
<PAGE>

the investors to acquire additional shares of common stock at an exercise price
of $.001 per share if the market price of our common stock did not achieve and
maintain a specific price during each of the three vesting periods. In February
2001, we negotiated an amendment to the adjustable warrants, which replaced the
variable amount of shares to be acquired with a fixed number of shares, and the
investors exercised the adjustable warrants in full, as so amended, for the
exercise price of $.001 per share. As a result of the exercise, we delivered to
the investors a total of 4,190,486 shares of common stock. We filed a
registration statement on Form S-3 with the Securities and Exchange Commission
to register the common stock so issued. We believe that all but 77 of these
shares were resold into the public market. The vesting warrants issued under the
transaction expired unexercised during February 2001. The closing warrants that
entitle the investors to purchase an additional 385,000 shares of our common
stock at an exercise price of $2.01 per share remain unexercised and
outstanding. The closing warrants expire in July 2003. We paid a commission to
the placement agent comprised of $80,000 in cash and warrants to purchase 79,150
shares of common stock at $1.7688 per share.

Sales of Assets

During our third quarter ended February 28, 2001, we sold our building in
Butler, New Jersey that was previously used as a manufacturing site by our
Interconnect Division. Net proceeds from the sale of the building were
approximately $660,000, versus a carrying amount of approximately $980,000, and
we recorded the resultant loss of $320,000 as an operating expense in our
consolidated financial statements.  We also sold a parcel of land located near
our Wenatchee campus.  The selling price and carrying value of the land and
improvements were both approximately $930,000.  During our fourth quarter ended
May 31, 2001, we sold substantially all of the assets used in the fabrication
portion of our U.S. Aerospace's Group's Engineering & Fabrication Division.  The
selling price of the assets was approximately  $250,000.  Within the U.S.
Electronic Group's Display Division we sold the equipment, inventory, and
intellectual property used to produce low power relays during the fourth quarter
of fiscal year 2001. Gross proceeds from the sale were $400,000.

Potential Sale of the European Aerospace Group

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, 2001, we had approximately $64 million in principal amount of 11 1/4%
senior subordinated notes outstanding.  Because we are in 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 or our approximately $13.7 million of 18% senior secured
notes.  We are required to pay our senior secured lenders at least $7.5 million
upon the sale of our European Aerospace Group.  Although at this time we have
not committed to the sale of the group, we have received several bona-fide
preliminary and final offers to purchase the group.  If these offers approximate
the final negotiated sales price for the group and we commit to the sale of the
group, the offers indicate that we will incur an impairment loss related to
goodwill and equipment of approximately $37 million. Consequently, we recorded
an impairment loss related to our European Aerospace Group goodwill of $25
million for the quarter ended February 28, 2001, and an additional impairment
loss of $12 million related to goodwill and equipment for the quarter ended May
31, 2001.  We are still in the process of selling the European Aerospace Group
and hope to have the sale finalized during our first or second quarter of fiscal
year 2002.

                                       48
<PAGE>

18% Senior Secured Loan

On March 1, 2001, we borrowed approximately $13.8 million from four
institutional lenders.  The loan bears interest at 18% per annum, payable
quarterly, and has a two-year term.  We have the right to defer and accrue a
portion of the interest on the loan, up to 1 1/4% per quarter, for up to a year
at the time of any interest payment.  We exercised this right for our interest
payments made in March and June 2001.  The loan is secured by our assets, the
assets of our U.S. subsidiaries, the common stock of all our operating
subsidiaries, and other intangibles.  We have used approximately $9.5 million of
the proceeds from the loan to repay our revolving line of credit in the U.S. and
to pay the interest payment on our 11 1/4% senior subordinated notes that was
due on February 1, 2001.  The remaining portion of the proceeds from the secured
loans has been used to repay other indebtedness, to pay the costs related to the
loan transaction, and for general corporate purposes.  In connection with the
secured loan, we issued warrants to purchase an aggregate of 4,036,978 shares of
our common stock at an exercise price of $.001 per share to the lenders.  The
value of these warrants using the Black Scholes valuation model is $1.6 million
at March 1, 2001, and is being amortized over the life of the loan using the
straight line method of amortization, as interest expense.  In addition, we paid
a commission of approximately $415,000 to the placement agent that represented
us in the transaction, and we issued warrants to purchase up to 692,074 shares
of our common stock to the placement agent, at an exercise price of $.4062 per
share.  The value of the placement agent's warrants using the Black Scholes
valuation model is $250,000 and is being amortized over the life of the loan
using the straight line method of amortization, as interest expense.

New Accounting Pronouncements
-----------------------------

In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (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 do not expect that
the adoption of SFAS No. 133 will have a material impact on our consolidated
financial statements.

In July 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS No.
142, Goodwill and Other Intangible Assets.  SFAS No. 141 requires that all
business combinations be accounted for under a single method, the purchase
method.  Use of the pooling-of-interests method no longer is permitted, although
poolings initiated prior to June 30, 2001 are grandfathered.  SFAS No. 141
requires that the purchase method be used for business combinations initiated
after June 30, 2001.  SFAS No. 142 requires that intangible assets with
indefinite lives and goodwill no longer be amortized to earnings, but instead be
reviewed for impairment.  The amortization of intangible assets with indefinite
lives and goodwill ceases upon adoption of the Statement, which the Company must
adopt by June 1, 2002.  Early adoption at June 1, 2001, is allowed.  SFAS No.
142 also requires an evaluation of intangible assets and their useful lives and
a transitional impairment test for certain intangible assets and goodwill.
After transition, the impairment tests are to be performed annually.  As of May
31, 2001, the Company had unamortized costs in excess of book value of acquired
subsidiaries of $351,000 and patents of $735,000, which will be subject to the
transition provisions of SFAS No. 141 and 142.  We do not expect that the
adoption of SFAS No. 141 and 142 will have a material impact on our consolidated
financial statements.

                                       49
<PAGE>

Subsequent Event
----------------

Effective June 1, 2001, we sold substantially all of the assets of the U.S.
Aerospace Group's Casting Division location in Entiat, Washington to two newly
formed limited liability companies owned by a private company.  The purchase
price was approximately $4.6 million, which consisted of approximately $1.5
million in cash (including $160,000 to be paid into escrow by the purchasers
within 120 days after closing and held for possible post-closing adjustments), a
$1.0 million long-term note payable to Pacific Aerospace, units in the newly
created limited liability companies valued by the parties at $1.0 million, and
the assumption of $1.1 million in liabilities.  We used the cash proceeds to
retire certain long-term debt related to the Entiat assets and to pay closing
costs related to the transaction.  The long-term note bears interest at 7% and
is payable in quarterly installments, interest only for the first year and then
principal and interest for five additional years.  Due to the uncertainties of
payment under this note, we have fully reserved against it as of the closing
date and it is not shown as an asset on our balance sheet.  The units in the
newly created limited liability companies have certain preferential rights,
including an accumulating preferred return equal to 5% of the par value of then
outstanding units and put rights subject to certain restrictions and
limitations.  Due to the inability to accurately estimate the fair market value
of the units, and the uncertainty surrounding any such value, we have assigned
no value to the units for financial statement purposes.

                                       50
<PAGE>

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 and variable rates.   Our fixed-rate
debt obligations are generally not callable until maturity and therefore market
fluctuations in interest rates will not affect our earnings for the period.  Our
variable rate debt obligations represent approximately 2% of our total debt
obligations.  Based upon these facts, we do not consider the market risk
exposure for interest rates to be material.  The fair value of such instruments
approximates their face value, except for our 11 1/4% senior subordinated notes,
which as of May 31, 2001, we believe were trading on the open market for
approximately 50% of face value.

We are subject to foreign currency exchange rate risk relating to receipts from
and payments to suppliers in foreign currencies.  Since approximately 47% of our
transactions are conducted in foreign currency, the exchange rate risk could be
material.  During fiscal years 1999, 2000 and 2001, the foreign currency
translation adjustments were losses of $1.1 million, $5.1 million and $2.9
million, net of tax, respectively.  We have not entered into any hedging
activity as of May 31, 2001.

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,
2001, we had purchase commitments for raw materials aggregating approximately
$1.7 million.  This amount relates to a titanium supply agreement with a fixed
price. This commitment at May 31, 2001 represented less than 2% of our
consolidated cost of goods sold for fiscal 2001.

                                       51
<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. as of May 31, 2000 and 2001, and the related
consolidated statements of operations and comprehensive loss, stockholders'
equity (deficit), and cash flows for each of the years in the three-period ended
May 31, 2001. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to report on these consolidated
financial statements based on the results of 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 audit to obtain reasonable assurance about whether the consolidated
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall consolidated financial statement presentation. We
believe that our audits provide a reasonable basis for our report.

In our opinion, the 2000 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Pacific
Aerospace & Electronics, Inc. as of May 31, 2000, and the results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America.

The accompanying 2000 and 2001 consolidated financial statements have been
prepared assuming that Pacific Aerospace & Electronics, Inc. will continue as a
going concern. As discussed in note 3 to the consolidated financial statements,
the Company has suffered recurring losses from operations and has a net capital
deficiency at May 31, 2001, which raise substantial doubt about the entity's
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.

Because of the significance of the uncertainty discussed in the preceding
paragraph, we are unable to express, and we do not express, an opinion on the
accompanying 2001 consolidated financial statements.

/s/ KPMG LLP

Seattle, Washington
July 27, 2001

                                      52
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                          Consolidated Balance Sheets

                             May 31, 2000 and 2001

<TABLE>
<CAPTION>
                                            Assets                                    2000         2001
                                                                                -------------  ------------
<S>                                                                             <C>            <C>
Current assets:
     Cash and cash equivalents                                                  $   2,154,000     4,095,000
     Accounts receivable, net of allowance for doubtful accounts, sales
        returns and allowances of $619,000 in 2000 and $451,000 in 2001            21,210,000    19,101,000
     Inventories                                                                   27,849,000    22,994,000
     Deferred income taxes                                                            872,000       115,000
     Prepaid expenses and other                                                     1,668,000       666,000
                                                                                -------------  ------------
                    Total current assets                                           53,753,000    46,971,000
                                                                                -------------  ------------
Property, plant and equipment, net                                                 44,076,000    26,754,000
                                                                                -------------  ------------
Other assets:
     Costs in excess of net book value of acquired subsidiaries, net of
        accumulated amortization of $2,659,000 in 2000 and $202,000 in 2001        38,291,000       351,000
     Patents, net of accumulated amortization of $509,000 in 2000
        and $428,000 in 2001                                                        1,158,000       735,000
     Deferred financing costs, net of accumulated amortization of
        $1,433,000 in 2000 and $2,477,000 in 2001                                   3,597,000     5,597,000
     Deferred income taxes                                                          2,303,000            --
     Other                                                                            404,000       408,000
                                                                                -------------  ------------
                    Total other assets                                             45,753,000     7,091,000
                                                                                -------------  ------------
                                                                                $ 143,582,000    80,816,000
                                                                                =============  ============

                        Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
     Accounts payable                                                           $  10,630,000    12,639,000
     Accrued liabilities                                                            4,589,000     5,209,000
     Accrued interest                                                               2,372,000     2,831,000
     Current portion of long-term debt                                              1,098,000       929,000
     Current portion of capital lease obligations                                     504,000       329,000
     Line of credit                                                                 5,379,000            --
                                                                                -------------  ------------
                    Total current liabilities                                      24,572,000    21,937,000
Long-term liabilities:
     Long-term debt, net of current portion                                         4,161,000    16,969,000
     Capital lease obligations, net of current portion                              1,065,000     1,005,000
     Senior subordinated notes payable                                             63,700,000    63,700,000
     Deferred income taxes                                                                 --     2,077,000
     Deferred rent and other                                                          316,000       242,000
                                                                                -------------  ------------
                    Total liabilities                                              93,814,000   105,930,000
                                                                                -------------  ------------
Stockholders' equity (deficit):
     Series B convertible preferred stock, $0.001 par value, 5,000,000 shares
        authorized, 34,529 and no shares issued and outstanding at May 31, 2000
        and 2001, respectively                                                             --            --
     Common stock, $0.001 par value, 100,000,000 shares authorized,
        30,283,621 and 38,833,151 shares  issued and outstanding at
        May 31, 2000 and 2001, respectively                                            30,000        39,000
     Additional paid-in capital                                                    83,173,000    86,917,000
     Accumulated other comprehensive loss                                          (6,250,000)   (9,165,000)
     Accumulated deficit                                                           27,185,000) (102,905,000)
                                                                                -------------- ------------
                    Total stockholders' equity (deficit)                           49,768,000   (25,114,000)
Commitments, contingencies and subsequent event                                            --            --
                                                                                -------------- ------------
                                                                                $ 143,582,000    80,816,000
                                                                                ============== ============
</TABLE>

See accompanying notes to consolidated financial statements.

                                      53
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

         Consolidated Statements of Operations and Comprehensive Loss

                    Years ended May 31, 1999, 2000 and 2001

<TABLE>
<CAPTION>
                                                                     1999               2000              2001
                                                              ---------------      -------------     --------------
<S>                                                           <C>                  <C>               <C>
Net sales                                                     $   107,366,000        112,694,000         109,288,000
Cost of sales                                                      86,302,000         92,063,000         101,048,000
                                                              ---------------      -------------    ----------------
                    Gross profit                                   21,064,000         20,631,000           8,240,000

Operating expenses                                                 22,039,000         24,533,000          67,201,000
                                                              ---------------      -------------    ----------------
                    Loss from operations                             (975,000)        (3,902,000)        (58,961,000)
                                                              ---------------      -------------    ----------------
Other income (expense):
     Interest income                                                  532,000             97,000              15,000
     Interest expense                                              (8,672,000)        (9,959,000)        (10,027,000)
     Other                                                         (6,393,000)            33,000             201,000
                                                              ---------------      -------------    ----------------
                    Total other expense                           (14,533,000)        (9,829,000)         (9,811,000)
                                                              ---------------      -------------    ----------------
                    Loss before income tax benefit (expense)
                        and extraordinary item                    (15,508,000)       (13,731,000)        (68,772,000)
Income tax benefit (expense)                                        2,639,000            (21,000)         (6,948,000)
                                                              ---------------      -------------    ----------------
                    Loss before extraordinary item                (12,869,000)       (13,752,000)        (75,720,000)

Extraordinary item, net of tax of $362,000                                 --            703,000                  --
                                                              ---------------      -------------    ----------------
                    Net loss                                      (12,869,000)       (13,049,000)        (75,720,000)
Other comprehensive loss:
     Foreign currency translation                                  (1,727,000)        (4,523,000)         (2,915,000)
     Income tax benefit (expense)                                     587,000           (587,000)                 --
     Valuation of available for sale securities                       436,000                 --                  --
                                                              ---------------      -------------    ----------------
                    Total other comprehensive loss                   (704,000)        (5,110,000)         (2,915,000)
                                                              ---------------      -------------    ----------------
                    Comprehensive loss                        $   (13,573,000)       (18,159,000)        (78,635,000)
                                                              ===============      =============    ================
Net loss per share:
     Basic                                                    $         (0.74)             (0.59)              (2.15)
     Diluted                                                            (0.74)             (0.59)              (2.15)

Shares used in computation of net loss per share:
        Basic                                                      17,359,491          21,955,473         35,283,347
        Diluted                                                    17,359,491          21,955,473         35,283,347

</TABLE>

See accompanying notes to consolidated financial statements.

                                      54
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

           Consolidated Statements of Stockholders' Equity (Deficit)

                    Years ended May 31, 1999, 2000 and 2001

<TABLE>
<CAPTION>
                                                             Series B
                                                   convertible preferred stock             Common stock            Additional
                                                  -----------------------------     ---------------------------      paid-in
                                                    Shares             Amount         Shares           Amount        capital
                                                  ----------         ----------     ----------       ----------    -----------
<S>                                               <C>                <C>            <C>              <C>           <C>
Balance at May 31, 1998                              100,000         $       --     15,395,723       $   15,000     57,830,000

Issuance of preferred stock,
   net of issuance costs of $370,000                  70,000                 --             --               --      6,630,000
Issuance of common stock for services                     --                 --        590,000            1,000      1,769,000
Cancellation of warrants                                  --                 --             --               --       (360,000)
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               --         72,000
Sale of common stock for cash, net of
   issuance costs of $344,000                             --                 --      2,585,000            3,000      4,823,000
Common shares redeemed in
   connection with a prior acquisition                    --                 --       (225,000)              --     (1,488,000)
Net loss                                                  --                 --             --               --             --
                                                  ----------         ----------     ----------       ----------    -----------

Balance at May 31, 1999                              161,035                 --     18,932,779           39,000     69,276,000

Issuance of common stock under
   employee stock purchase plan, net of
   related expenses of $12,000                            --                 --        142,696               --        163,000
Sale of common stock for cash, net of
   issuance costs of $788,000                             --                 --      1,598,000            1,000      4,005,000
Issuance of warrants                                      --                 --             --               --         60,000
Exercise of warrants for cash, net                        --                 --         25,000               --         86,000
Issuance of common stock in exchange
   for senior subordinated notes                          --                 --      2,902,806            3,000      9,650,000
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        (67,000)
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     83,173,000

Issuance of common stock under
   employee stock purchase plan,
   net of related expenses of $10,000                     --                 --        407,090            1,000        167,000
Issuance of common stock on
   conversion of Series B preferred
   stock, net of issuance costs
   of $18,000                                        (34,529)                --      2,809,094            3,000        (21,000)
Sale of common stock and
   warrants for cash, net of
   issuance costs of $173,000                             --                 --      1,142,860            1,000      1,712,000
Exercise of warrants for cash, net                        --                 --      4,190,486            4,000             --
Issuance of warrants                                      --                 --             --               --      1,886,000
Foreign currency translation                              --                 --             --               --             --
   adjustment
Net loss                                                  --                 --             --               --             --
                                                  ----------         ----------     ----------       ----------    -----------
Balance at May 31, 2001                                   --         $       --     38,833,151       $   39,000     86,917,000
                                                  ==========         ==========     ==========       ==========    ===========

<CAPTION>
                                                    Accumulated                           Total
                                                       other                          stockholders'
                                                   comprehensive     Accumulated         equity
                                                       loss            deficit          (deficit)
                                                   -------------     ------------     -------------
<S>                                                <C>               <C>              <C>
Balance at May 31, 1998                                 (436,000)      (1,267,000)       56,142,000

Issuance of preferred stock,
   net of issuance costs of $370,000                          --               --         6,630,000
Issuance of common stock for services                         --               --         1,770,000
Cancellation of warrants                                      --               --          (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
Sale of common stock for cash, net of
   issuance costs of $344,000                                 --               --         4,826,000
Common shares redeemed in
   connection with a prior acquisition                        --               --        (1,488,000)
Net loss                                                      --      (12,869,000)      (12,869,000)
                                                   -------------     ------------     -------------

Balance at May 31, 1999                               (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
Sale of common stock for cash, net of
   issuance costs of $788,000                                 --               --         4,006,000
Issuance of warrants                                          --               --            60,000
Exercise of warrants for cash, net                            --               --            86,000
Issuance of common stock in exchange
   for senior subordinated notes                              --               --         9,653,000
Issuance of common stock on
   conversion of Series B
   preferred stock, net of
   issuance costs of $60,000                                  --               --           (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                               (6,250,000)     (27,185,000)       49,768,000

Issuance of common stock under
   employee stock purchase plan,
   net of related expenses of $10,000                         --               --           168,000
Issuance of common stock on
   conversion of Series B preferred
   stock, net of issuance costs
   of $18,000                                                 --               --           (18,000)
Sale of common stock and
   warrants for cash, net of
   issuance costs of $173,000                                 --               --         1,713,000
Exercise of warrants for cash, net                            --               --             4,000
Issuance of warrants                                          --               --         1,886,000
Foreign currency translation                          (2,915,000)              --        (2,915,000)
   adjustment
Net loss                                                      --      (75,720,000)      (75,720,000)
                                                   -------------     ------------     -------------

Balance at May 31, 2001                               (9,165,000)    (102,905,000)      (25,114,000)
                                                   =============     ============     =============
</TABLE>

See accompanying notes to consolidated financial statements.

                                      55
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                     Consolidated Statements of Cash Flows

                    Years ended May 31, 1999, 2000 and 2001

<TABLE>
<CAPTION>
                                                                                 1999           2000           2001
                                                                            -------------  ------------  --------------
<S>                                                                         <C>            <C>           <C>
Cash flow from operating activities:
     Net loss                                                               $ (12,869,000)  (13,049,000)    (75,720,000)
     Adjustments to reconcile net loss to net
        cash used in operating activities:
           Depreciation and amortization                                        6,705,000     7,741,000       7,334,000
           Allowance on note receivable and guarantees                          2,884,000            --              --
           Impairment of certain long lived assets                              3,275,000     5,304,000      48,946,000
           Writedown of inventories                                             2,208,000            --       1,600,000
           Realized loss on investment                                          4,943,000        19,000              --
           Gain on early extinguishment of debt                                        --      (703,000)             --
           Other nonoperating (income) expenses                                   750,000        (8,000)       (144,000)
           Income tax (benefit) expense                                        (4,287,000)      151,000       5,844,000
           Changes in operating assets and liabilities:
              Accounts receivable                                                (121,000)    3,250,000       1,661,000
              Inventories                                                         543,000    (3,072,000)      2,445,000
              Prepaid expenses and other current assets                          (421,000)     (137,000)       (347,000)
              Other assets                                                      1,077,000    (2,307,000)       (114,000)
              Accounts payable, accrued liabilities and other liabilities      (5,059,000)   (2,396,000)      6,895,000
                                                                            -------------  ------------  --------------
                    Net cash used in operating activities                        (372,000)   (5,207,000)     (1,600,000)
                                                                            -------------  ------------  --------------

Cash flow from investing activities:
     Acquisition of property, plant and equipment                              (8,040,000)   (4,867,000)     (3,710,000)
     Acquisition of subsidiaries                                              (69,752,000)   (1,350,000)             --
     Proceeds from sale of property, plant and equipment                               --            --       2,254,000
     Issuance of notes receivable                                              (1,458,000)   (1,505,000)             --
     Other changes, net                                                           (24,000)       49,000         (20,000)
                                                                            -------------  ------------  --------------
                    Net cash used in investing activities                     (79,274,000)   (7,673,000)     (1,476,000)
                                                                            -------------  ------------  --------------
Cash flow from financing activities:
     Net borrowings (repayments) under line of credit                          (1,511,000)    5,218,000         319,000
     Proceeds from long-term debt                                              72,160,000            --       4,802,000
     Payments on long-term debt and capital leases                             (5,752,000)   (2,603,000)     (1,698,000)
     Proceeds from sale of common stock and warrants, net                       4,898,000     4,169,000       1,863,000
     Proceeds from sale of preferred stock, net                                 6,630,000       (60,000)             --
     Proceeds from exercise of warrants                                                --        86,000           4,000
     Other changes, net                                                                --        24,000              --
                                                                            -------------  ------------  --------------
                 Net cash provided by financing activities                     76,425,000     6,834,000       5,290,000
                                                                            -------------  ------------  --------------
                 Net increase (decrease) in cash and cash equivalents          (3,221,000)   (6,046,000)      2,214,000

Effect of exchange rates on cash                                                 (106,000)       66,000        (273,000)

Cash and cash equivalents at beginning of year                                 11,461,000     8,134,000       2,154,000
                                                                            -------------  ------------  --------------
Cash and cash equivalents at end of year                                    $   8,134,000     2,154,000       4,095,000
                                                                            =============  ============  ==============

Supplemental cash flow: Cash paid during the year for:
        Interest                                                            $   5,296,000     9,563,000       8,524,000
        Income taxes                                                              411,000     2,232,000         295,000
Acquisition of subsidiaries:
     Fair value of assets acquired and resulting goodwill, excluding cash      86,593,000     9,801,000              --
     Liabilities assumed                                                       16,811,000     5,814,000              --
Noncash investing and financing activities:
     Seller financed acquisition of property, plant and equipment                 241,000            --              --
     Conversion of notes and accrued interest to common stock                          --    11,457,000              --
     Short-term obligations refinanced with long-term debt                             --            --       9,306,000
     Reclassification of property, plant and equipment to other assets          1,217,000            --              --
     Issuance of warrants in connection with debt                                      --            --       1,886,000
</TABLE>

See accompanying notes to consolidated financial statements.

                                      56
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

(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 1999 and 2000 amounts have been reclassified to conform
              with the 2001 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 or fair market
              value of the underlying assets. 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 3 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.

                                                                     (Continued)
                                      57
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

              Expenditures for maintenance and repairs are charged to expense as
              incurred. Upon sale or retirement, the cost and related
              accumulated depreciation or amortization is 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 certain
              debt instruments and are being amortized using the straight-line
              method over life of the related debt instruments, currently
              ranging from 2 to 15 years.

       (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. In certain instances
              the Company recognizes revenues from long-term, fixed-price
              contracts on the percentage of completion method measured by job
              progress. Contract costs for long-term contracts include all
              direct material and labor costs related to contract performance.
              Provisions for estimated losses on uncompleted contracts are made
              in the period in which losses are determined. Changes in job
              performance, job conditions, and estimated profitability,
              including those arising from contract penalty provisions, and
              final contract settlements may result in revisions to costs and
              income and are recognized in the period in which the revisions are
              determined. Profit incentives are included in revenue when their
              realization is reasonably assured. When formal customer approval
              is necessary, the Company defers revenue recognition until such
              approval is received.

       (g)    Research and Development

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

                                                                     (Continued)
                                      58
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

       (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.


       (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
              the 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 Loss Per Share

              Basic loss per share is computed using the weighted average number
              of common shares outstanding during the period. Diluted 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, 2000 and 2001, 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, 1999, 2000 and 2001.


                                                                     (Continued)
                                      59
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

       (l)    Comprehensive 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 foreign currency
              translation adjustments.


       (m)    Use of Estimates

              The preparation of consolidated financial statements in conformity
              with GAAP in the United States of America 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 June 1998, the Financial Accounting Standards Board (FASB)
              issued Statement of Financial Accounting Standards (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. The Company
              does not expect that the adoption of SFAS No. 133 will have a
              material impact on the Company's consolidated financial
              statements.

              In July 2001, the FASB issued SFAS No. 141, Business Combinations,
              and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No.
              141 requires that all business combinations be accounted for under
              a single method, the purchase method. Use of the
              pooling-of-interests method no longer is permitted, although
              poolings initiated prior to June 30, 2001 are grandfathered. SFAS
              No. 141 requires that the purchase method be used for business
              combinations initiated after June 30, 2001. SFAS No. 142 requires
              that intangible assets with indefinite lives and goodwill no
              longer be amortized to earnings, but instead be reviewed for
              impairment. The amortization of intangible assets with indefinite
              lives and goodwill ceases upon adoption of the Statement, which
              the Company must adopt by June 1, 2002. Early adoption at June 1,
              2001, is allowed. SFAS No. 142 also requires an evaluation of
              intangible assets and their useful lives and a transitional
              impairment test for certain intangible assets and goodwill. After
              transition, the impairment tests are to be performed annually. As
              of May 31, 2001, the Company had unamortized costs in excess of
              book value of acquired subsidiaries of $351,000, and patents of
              $735,000, which will be subject to the transition provisions of
              SFAS No. 141 and 142. The Company does not expect that the
              adoption of SFAS No. 141 and 142 will have a material impact on
              the consolidated financial statements.


                                                                     (Continued)
                                      60
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

(3)    Going Concern

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

       Cash used in operating activities was $1,600,000 for fiscal year 2001
       compared to $5,207,000 and $372,000 in fiscal years 2000 and 1999,
       respectively. 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. The
       Company has also downsized, closed, sold or is in process of selling
       certain of its subsidiaries that have continued to produce negative cash
       flow from operations. The Company is also in process of selling its
       European Aerospace Group to substantially reduce its debt and
       corresponding interest expense. 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 its assets for
       amounts in excess of book value.

       The Company's existing cash and credit facilities will not be sufficient
       to meet its obligations as they become due. Consequently, the Company
       will need to obtain additional cash. The Company's actual cash needs will
       depend primarily on the amount of cash generated from or used by its
       operations and financing activities. The Company cannot predict
       accurately the amount or timing of its future cash needs. The Company's
       semi-annual interest payment of approximately $3.6 million on its 11 1/4%
       senior subordinated notes was due on August 1, 2001. The Company did not
       make that payment at that time and does not currently have sufficient
       cash to make the interest payment on its 11 1/4% senior subordinated
       notes. The Company will also need to raise additional cash to make future
       interest payments on the Senior Notes, as well as other debt instruments,
       and to fund its operations. If the Company is unable to obtain sufficient
       cash when needed to fund its operations, to make these interest payments,
       and to pay our other obligations when due, it may be forced to seek
       protection from creditors under the bankruptcy laws.

       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, 2000 and
       2001 are $4.9 million, $5.3 million, and $48.9 million, respectively, in
       non-cash charges related to the impairment of long-lived assets,
       primarily goodwill and equipment. The Company reviews 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.


                                                                     (Continued)
                                      61
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

       During the year ended May 31, 1999 the Company determined that due to
       continued losses related to the U.S. Electronics Group's Displays
       Division, a impairment of approximately $4.7 million existed at 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 Electronics
       Group's Interconnect Division to its estimated fair value, $1.4 million.

       During the year ended May 31, 2000 due to continuing losses, weakness 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 of long-lived assets
       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.

       Based upon estimated net realizable value of certain assets, the Company
       recognized the following impairment charges for the year ended May 31,
       2001:

         Within the European Aerospace Group the Company recognized a $37.0
         million charge to reduce the $33.0 million carrying value of goodwill
         and the $13.6 million carrying value of manufacturing equipment
         associated with our European Aerospace Group, to the estimated net
         realizable value of the manufacturing equipment, $9.6 million.

         Within the U.S. Aerospace Group, the Company recognized an impairment
         charge of $5.5 million to reduce the $6.4 million carrying value of
         property and manufacturing equipment used at the Company's U.S.
         Aerospace Group's Casting Division's Entiat, Washington location to net
         realizable value, approximately $0.9 million. The Company recognized a
         $0.8 million impairment charge to reduce the carrying value of the
         manufacturing equipment located at its Tacoma casting location to zero,
         the estimated net realizable value. The Company also recognized charges
         of $3.3 million to reduce the $3.5 million carrying value of goodwill
         and manufacturing equipment used in the Engineering & Fabrication
         Division to estimated net realizable value, $0.2 million.

         Within the U.S. Electronics Group, the Company recognized a charge of
         $0.6 million to reduce the $1.0 million of manufacturing equipment used
         to produce low power relays to its net realizable value, $0.4 million.
         The Company recognized a $320,000 charge to reduce the carrying value
         of an unused manufacturing facility of $980,000 to net realizable
         value, $660,000.


                                                                     (Continued)
                                      62
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

       The Company also completed an analysis of the estimated future cash flows
       of certain other long-lived assets including goodwill and patents. Based
       upon this analysis the Company recognized additional impairment charges
       of $1.0 million within the U.S. Electronics Group to reduce goodwill to
       net realizable value, and $0.3 million within the U.S. Aerospace Group to
       reduce patents to net realizable value.

       The Company will continue to analyze long-lived and identifiable
       intangible assets in the future to determine possible impairment charges.
       Future evaluations could result in additional impairment charges and
       those charges could be material. At May 31, 2001, the carrying value of
       long-lived assets, including property, plant and equipment, goodwill, and
       patents, was $27.8 million.


(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, 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        9,111,000
      Depreciation and amortization            1,659,000        3,170,000         1,684,000          192,000        6,705,000
      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>


                                                                     (Continued)
                                      63
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001



       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>

       Year ended May 31, 2001:

<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           $     29,121,000        51,597,000       28,570,000                --      109,288,000
       Net sales between segments                491,000                --               --          (491,000)              --
       Income (loss) from operations         (19,451,000)      (35,010,000)       2,809,000        (7,309,000)     (58,961,000)
       Identifiable assets                    17,177,000        34,419,000       17,102,000        12,118,000       80,816,000
       Capital expenditures                      713,000         2,111,000          571,000           315,000        3,710,000
       Depreciation and amortization           2,204,000         3,180,000        1,394,000           556,000        7,334,000
       Interest income                                --             8,000               --             7,000           15,000
       Interest expense                          385,000         3,976,000          138,000         5,528,000       10,027,000
</TABLE>


The Company had net sales to one customer comprising greater than 10% of each
year's net sales, aggregating 12%, 10% and 12.5% in the years ended May 31,
1999, 2000 and 2001, respectively.

The Company had accounts receivable from one customer comprising greater than
10% of accounts receivable, aggregating 11% as of May 31, 2000. The Company had
accounts receivable from one customer comprising greater than 10% of accounts
receivable, aggregating 10.6% as of May 31, 2001.

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

                                                                  (Continued)
                                      64
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001


       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 $2,772,000, $2,656,000 and $4,623,000 from one supplier
       during the years ended May 31, 1999, 2000 and 2001, respectively.

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

       At May 31, 2001, the Company had purchase commitments for raw materials
       aggregating $1,722,000.


(6)    Business Acquisitions

       In July 1998, the Company purchased all of the outstanding stock of
       Aeromet International PLC ("Aeromet"). The purchase price consisted of
       (pound)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 of in excess of net book value         1,683,000
               Liabilities assumed                        (3,303,000)
                                                      --------------
                            Total                     $    1,300,000
                                                      ==============

                                                                     (Continued)
                                      65
<PAGE>


                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001


       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
                                                   =============

       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 2001, costs in excess of net book value of acquired subsidiaries in
       the amounts of $33.0 million relating to Aeromet and $1.8 million
       relating to Skagit, were written off due to impairment. 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 relating
       to Skagit and $2,400,000 relating to Nova-Tech, 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 year 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.

                                                                (unaudited)
                                                             Year ended May 31,
                                                                   2000
                                                           --------------------

             Net sales                                        $     117,965,000
             Loss from operations                                   (11,457,000)
             Net loss                                               (17,302,000)

             Net loss per share:
                Basic                                                     (0.79)
                Diluted                                                   (0.79)

             Shares used in computation of net loss per share:
                Basic                                                21,955,473
                Diluted                                              21,955,473


                                                                     (Continued)
                                      66
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001


       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.

(7)    Allowance for Doubtful Accounts, Sales Returns and Allowances

       The Company records a provision for accounts receivable that the Company
       believes may not be collectible and for products that may be returned in
       the future. Accounts receivable are reported net an allowance for
       doubtful accounts, sales returns and allowances on the consolidated
       balance sheets. The provision for bad debt expense is included in the
       operating expenses on the consolidated statements of operations and
       comprehensive income (loss), while net sales are shown net of sales
       returns and allowances. When specific accounts are determined to be
       uncollectable and when inventories are returned, the Company eliminates
       the balance from accounts receivable and reduces the allowance by a
       corresponding amount. A reconciliation of the allowance for doubtful
       accounts, sales returns and allowances is as follows:

               Balance at May 31, 1999                    $ 553,000

               Charged to operating expense                 305,500
               Charged to net sales                           2,500
               Specific account balance write-off          (234,000)
               Effect of exchange rates                      (8,000)
                                                          ---------
               Balance at May 31, 2000                      619,000

               Charged to operating expense                   3,000
               Specific account balance write-off          (163,000)
               Effect of exchange rates                      (8,000)
                                                          ---------
               Balance at May 31, 2001                    $ 451,000
                                                          =========



(8)    Inventories

       Inventories at May 31 consist of the following:

                                            2000             2001
                                        ------------     ------------

               Raw materials            $  7,204,000        5,032,000
               Work in progress           13,581,000       10,990,000
               Finished goods              7,064,000        6,972,000
                                        ------------     -------------

                                        $ 27,849,000       22,994,000
                                        ============     =============

                                                                     (Continued)


                                      67
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

(9)    Property, Plant and Equipment

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

<TABLE>
<CAPTION>
                                                               2000              2001
                                                           ------------      ------------
<S>                                                      <C>               <C>
           Land                                            $  2,046,000         1,081,000
           Buildings                                          8,687,000         5,687,000
           Leasehold improvements                             3,509,000         3,693,000
           Machinery and equipment                           52,213,000        28,190,000
           Office equipment, furniture and fixtures           2,998,000         4,134,000
                                                           ------------      ------------
                                                             69,453,000        42,785,000
           Less accumulated depreciation and amortization    26,301,000        16,071,000
                                                           ------------      ------------
                                                             43,152,000        26,714,000
           Construction and purchases in progress               924,000            40,000
                                                           ------------      ------------
                                                           $ 44,076,000        26,754,000
                                                           ============      ============
</TABLE>

       The Company recognized depreciation of property, plant and equipment of
       $5,448,000, $5,942,000 and $6,243,000 during the years ended May 31,
       1999, 2000 and 2001, respectively.

       The Company includes computer software and hardware within office
       equipment, furniture and fixtures. Software is amortized over its
       estimated useful life, usually three years.

       Included in property, plant and equipment are costs of $5,874,000 and
       $2,412,316 and related accumulated amortization of $1,049,000 and
       $1,137,515 recorded under capital leases at May 31, 2000 and 2001,
       respectively.


(10)   Credit Facility

       At May 31, 2000, the Company's primary banking relationships included a
       revolving line of credit of up to $6.3 million in the U.S. and a
       revolving line of credit of up to approximately $5.0 million ((pound)3.5
       million) in the U.K. Both of these credit facilities have been replaced
       with a senior secured term loan of $13.8 million from four institutional
       lenders. The loan bears interest at 18% per annum, payable quarterly, and
       has a two-year term. The Company has the right to defer and accrue a
       portion of the interest on the loan, up to 5% per year, for up to a year
       at the time of any interest payment. The loan is secured by the Company's
       assets, the assets of its United States subsidiaries, and other
       intangibles. This senior secured loan is a term loan rather than a
       revolving loan. As a result, if the Company makes payments of principal
       before the loan's maturity, additional loan proceeds will not become
       available, and the loan will not provide an additional source of cash to
       fund the Company's operations or to meet the Company's obligations as
       they become due.

                                                                     (Continued)

                                      68
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001


(11)   Long-Term Debt

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

<TABLE>
<CAPTION>
                                                                                                    2000              2001
                                                                                               ----------------  --------------
<S>                                                                                            <C>               <C>
       Note payable to four institutional lenders, quarterly interest payments at 18%
           with 5% deferred up to one year, with principal balance due in full March
           2003.                                                                                $            --      13,731,000
       Industrial revenue bond payable to a bank in monthly installments of $19,200,
           including interest at 8.12%, through July 2004                                               787,000         613,000
       Note payable to a bank in monthly installments of $7,000, including interest
           at LIBOR plus 2% (6.12% at May 31, 2001), with the remaining principal
           balance due in full in March 2008                                                            658,000         628,000
       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                                                                                  410,000         363,000
       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                                                                1,701,000       1,232,000
       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                                                                  402,000         200,000
       Note payable to a bank in monthly installments of $10,127, including interest
           at LIBOR plus 2.25% (6.43% at May 31, 2001) through June  2008                             1,156,000       1,131,000
       Notepayable 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                                                             145,000              --
                                                                                                ---------------  --------------
                                                                                                      5,259,000      17,898,000

       Less current portion                                                                           1,098,000         929,000
                                                                                                ---------------  --------------
                   Long-term debt, net of current portion                                       $     4,161,000      16,969,000
                                                                                                ===============  ==============
</TABLE>
                                                                     (Continued)

                                      69
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

       Subsequent to year end, the industrial revenue bond agreement and the
       subordinated note to the City of Entiat, as well as several vehicle and
       equipment loans, were repaid in full using proceeds from the sale of the
       U.S. Aerospace Group's casting facility located in Entiat, Washington.

       Certain notes payable require, among other items, that the Company
       maintain minimum working capital, tangible net worth and debt to tangible
       net worth ratios. At May 31, 2001, the Company was not in compliance with
       these covenants. Management has received a forbearance letter from the
       lender waiving the violations. There can be no assurance that the lender
       will not require the amounts immediately due and payable if violations of
       the covenants continue. The amount outstanding under these agreements was
       approximately $1,800,000 as of May 31, 2001.

       Scheduled principal maturities of long-term debt at May 31, 2001 are as
       follows for each of the following fiscal year-ends:

                         2002                     $    929,000
                         2003                       14,586,000
                         2004                          634,000
                         2005                          175,000
                         2006                          181,000
                         Thereafter                  1,393,000
                                                  -------------
                                                  $ 17,898,000
                                                  =============

       Long-term debt is secured by substantially all assets of the Company.


(12)   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.

       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, 2001.

                                                                     (Continued)
                                      70
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

       restrictive covenant 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, 2001.

       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 was recorded in the
       consolidated financial statements as an extraordinary item.

                                                                     (Continued)

                                      71
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

(13)   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, 2001 are as follows for each of the
              following fiscal year-ends:

<TABLE>
<S>                                                                                            <C>
                    2002                                                                       $           380,000
                    2003                                                                                   338,000
                    2004                                                                                   324,000
                    2005                                                                                   241,000
                    2006                                                                                   155,000
                    Thereafter                                                                             170,000
                                                                                                  --------------------
                                                                                                         1,608,000

                    Less amounts representing interest ranging from 6% to 16%                              274,000
                                                                                                  --------------------
                              Present value of net minimum capital lease obligations                     1,334,000

                    Less current portion                                                                   329,000
                                                                                                  --------------------
                              Capital lease obligations, less current portion                  $         1,005,000
                                                                                                  ====================
</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, 2001 are as follows for each of the
              following fiscal year-ends:

                                    2002                 $         4,931,000
                                    2003                           4,655,000
                                    2004                           3,822,000
                                    2005                           3,676,000
                                    2006                           3,271,000
                                    Thereafter                    20,619,000
                                                            -------------------
                                                         $        40,974,000
                                                            ===================


              Total rent expense during the years ended May 31, 1999, 2000 and
              2001 amounted to $3,356,000, $4,191,000 and $5,917,000,
              respectively. Included in rent expense for the year ended May 31,
              2001 is an accrual of approximately $500,000 related to the
              abandonment of certain manufacturing facility operating leases.

                                                                     (Continued)
                                      72
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

(14)   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, 2000 and 2001, 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. No underwriter warrants were exercised during the years ended
       May 31, 1999, 2000 and 2001.

       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.

       In July 2000 the Company closed the first of two proposed installments 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 approximately $2.0 million. The Company filed 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").
       If the Registration Statement had become effective within 60 days after
       the first closing a second closing would have occurred and the investors
       would have paid an additional $1.5 million and received 857,140
       additional shares of Common Stock. However, the Registration Statement
       did not become effective within 60 days of the first closing and
       consequently the second installment did not close. In addition the
       Company also issued to the investors certain adjustable, vesting, and
       closing warrants to purchase additional shares of the Company's common
       stock. The adjustable warrants permitted the investors to acquire
       additional shares of common stock at an exercise price of $.001 per share
       if the market price of the Company's common stock did not achieve and
       maintain a specific price during each of the three vesting periods.
       Subsequent to issuance of the adjustable warrants the Company negotiated
       an amendment to the adjustable warrants, which replaced the variable
       calculation of shares to be acquired with a fixed number of shares. In
       February 2001, the investors exercised the adjustable warrants in full,
       as so amended, for the exercise price of $.001 per share. As a result of
       the exercise, the Company delivered to the investors a total of 4,190,486
       shares of common stock. The vesting warrants issued under the transaction
       expired unexercised during February 2001. The closing warrants that
       entitle the investors to purchase an additional 385,000 shares of our
       common stock at an exercise price of $2.01 per share remain unexercised
       and outstanding at May 31, 2001. The closing warrants expire in July
       2003.

                                                                     (Continued)
                                      73
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

(15)   Convertible Preferred Stock - 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 of common stock. Net proceeds to the Company, subsequent to
       offering costs of $370,000, were $6,630,000.

       As of May 31, 2000 and 2001, 135,471 and 170,000 shares, respectively, of
       Series B have been converted into 7,227,454 and 10,036,548 shares,
       respectively, of common stock.

(16)   Warrants

       The Company periodically issues warrants to purchase common shares in
       connection with common stock, preferred stock, debt and certain
       consulting services. When warrants are issued in exchange for consulting
       or other services, the warrants are valued using the Black Scholes method
       or the fair value of the services received, whichever is more reasonably
       determinable. The value of the warrants are recorded as additional paid
       in capital and a deferred expense amortizable over the term of the
       services to be received. A summary of the Company's warrants, excluding
       warrants issued in connection with the public offering in July 1996, is
       as follows:

                                                                   Weighted
                                                                average price
                                               Warrants           of shares
                                           ----------------   -----------------

           Balance at May 31, 1998             1,676,388   $         4.360

           Granted                                97,221             7.200
           Exercised                          (1,290,000)            4.620
                                           ----------------
           Balance at May 31, 1999               483,609             4.240
           Granted                               200,000             6.500
           Canceled                              (25,000)            3.450
                                           ----------------
           Balance at May 31, 2000               658,609             4.960
           Granted                             9,383,688             0.098
           Exercised                          (4,190,486)            0.001
           Canceled                             (273,609)            6.870
                                           ----------------
           Balance at May 31, 2001             5,578,202             0.471
                                           ================

                                      74
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

       The following summarizes warrants outstanding, excluding warrants issued
       in connection with the public offering in July 1996, at May 31, 2001:

<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>
               $    0.001-1.99          4,808,202           4.81          $      0.03
                     2.00-3.99            620,000           2.31                 2.19
                     4.00-5.99             50,000           1.92                 5.50
                     6.00-7.99             50,000           1.92                 7.50
                     8.00-9.99             50,000           1.92                 9.50
                                    --------------
                                        5,578,202
                                    ==============


</TABLE>

(17)   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, 2000 and 2001, the Company had not issued any stock
              appreciation rights, stock and cash bonuses, restricted stock, or
              performance units under either plan.

                                      75
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

       (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, 2000 and 2001, 380,804 and
              338,304 shares, respectively, were available for future issuance.
              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. During the year ended May 31, 2001, 42,500 options were
              issued under the plan. Options issued under the plan during the
              years ended May 31, 1999 and 2000 vested immediately upon
              issuance. Of the options issued under the plan during the year
              ended May 31, 2001, 2,500 vested immediately and 40,000 were
              unvested. Included in compensation expense was $89,000 for the
              year ended May 31, 1999, resulting from the shares issued. For the
              years ended May 31, 1999, 2000 and 2001, 41,942, 86,637 and
              129,137 options were outstanding, respectively.


       (c)    Retirement Plan

              The Company maintains a 401(k) plan covering all eligible
              employees who meet service requirements as provided in the plan.
              The Company's contribution to the profit-sharing plan is
              determined annually by the Board of Directors. The Company
              contributed $48,000, $59,000 and $70,180 to the plan during the
              years ended May 31, 1999, 2000 and 2001, 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, 2000 and 2001,
              41,942, 142,696 and 407,090 shares respectively, were purchased by
              employees under the plan.

                                      76

<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

              As the Company applies APB Opinion No. 25 and related
              interpretations in accounting for its option plans and employee
              stock purchase plans, no compensation costs have been recognized
              for stock options issued to employees. Had compensation costs for
              the stock option and stock purchase plan 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>
                                                         1999              2000               2001
                                                 ------------------  ---------------   ----------------
               <S>                               <C>                 <C>               <C>
               Net loss:
                   As reported                   $    (12,869,000)     (13,049,000)      (75,720,000)
                   Pro forma                          (14,970,000)     (14,555,000)      (75,848,000)

               Net loss per share:
                   As reported:
                     Basic                                  (0.74)           (0.59)            (2.15)
                     Diluted                                (0.74)           (0.59)            (2.15)
                   Pro forma:
                     Basic                                  (0.86)           (0.66)            (2.15)
                     Diluted                                (0.86)           (0.66)            (2.15)

               Shares used in computation of
                   net loss per share:
                     Basic                             17,359,491       21,955,473        35,283,347
                     Diluted                           17,359,491       21,955,473        35,283,347
</TABLE>

              The fair value of the options granted during the years ended May
              31, 1999, 2000 and 2001 is estimated as $474,000, $1,253,000 and
              $98,000, 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 148%,
              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 is included in the pro forma amounts disclosed above.

              Pro forma compensation under the employee stock purchase plan
              during the years ended May 31, 1999, 2000, and 2001 is $8,000,
              $78,000, and $30,000, respectively.

                                      77
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

              A summary of the activity under the Company's Long-Term Investment
              and Incentive Plans and Independent Director Stock Plan is as
              follows:

<TABLE>
<CAPTION>
                                                        Shares of common stock
                                                   -------------------------------       Weighted
                                                     Available         Options         average price
                                                      options        under plans         of shares
                                                   -------------  ----------------    ----------------
                 <S>                               <C>
                 Balance at May 31, 1998              1,211,925        2,231,116      $        5.09

                 Shares granted                            (600)              --               6.06

                 Options granted                     (1,861,025)       1,861,025               2.49
                 Options expired                         40,000          (40,000)              1.98
                 Options canceled                     1,466,056       (1,466,056)             (3.70)
                 Options terminated                      72,500          (72,500)              6.13
                                                   -------------  ----------------

                 Balance at May 31, 1999                928,856        2,513,585               3.29

                 Options authorized by new plan       4,000,000               --                 --
                 Options granted                       (950,000)         950,000               1.62
                 Options terminated                       5,000           (5,000)              2.53
                                                   -------------  ----------------

                 Balance at May 31, 2000              3,983,856        3,458,585               1.61

                 Options granted                       (366,500)         366,500                .38
                 Options expired                         60,000          (60,000)              2.53
                 Options terminated                      30,500          (30,500)              2.14
                                                   -------------  ----------------

                 Balance at May 31, 2001              3,707,856        3,734,585               2.42
                                                   =============  ================
</TABLE>

              The following summarizes options from both Long-Term Investment
              and Incentive plans and the Independent Director Stock plan
              outstanding at May 31, 2001:

<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            1,333,137           8.86          $     1.27           1,288,137       $      1.28
                2.00 - 3.99            1,793,888           6.45                2.51           1,741,888              2.52
                4.00 - 6.00              607,560           5.17                4.69             607,560              4.69
                                  ----------------                                         ---------------

                                       3,734,585                                              3,637,585
                                  ================                                         ===============
</TABLE>

                                                                     (Continued)

                                      78
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

(18)   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 an outstanding note receivable.


(19)   Income Taxes

       Total income tax benefit (expense) is as follows:

                                         1999        2000       2001
                                      ----------  ---------  -----------

             Current:
                 Federal            $    262,000        --           --
                 Foreign              (1,422,000)  (41,800)  (1,796,000)
             Deferred:
                 Federal               3,799,000    (8,000)  (4,966,000)
                 Foreign                      --    28,800     (186,000)
                                      ----------  ---------  -----------

                      Total         $  2,639,000   (21,000)  (6,948,000)
                                      ==========  =========  ===========

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

<TABLE>
<CAPTION>
                                                            1999          2000          2001
                                                       ------------   -----------   -----------
             <S>                                      <C>             <C>           <C>
             Domestic                                 $ (18,992,000)  (11,421,000)  (29,564,000)
             Foreign                                      3,484,000    (2,310,000)  (39,208,000)
                                                       ------------   -----------   -----------

                      Loss before income tax benefit
                         (expense)                    $ (15,508,000)  (13,731,000)  (68,772,000)
                                                       ============   ===========   ===========
</TABLE>

       There are no undistributed earnings of the Company's foreign subsidiaries
       for which no U.S. income taxes have been provided at May 31, 2000 and
       2001. Current foreign income tax expense during the year ended May 31,
       2001, includes $1.7 million due to the disallowance of previously
       deducted interest expense remitted to the U.S. parent corporation.

                                                                     (Continued)

                                      79
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

       A reconciliation of the U.S. federal statutory tax rate of 34% and the
       Company's effective tax rates of 17%, 0% and (10)% during the years ended
       May 31, 1999, 2000 and 2001, respectively, is as follows:

<TABLE>
<CAPTION>
                                                         1999          2000           2001
                                                     -----------    ----------    -----------
             <S>                                     <C>            <C>           <C>
             Computed expected income tax benefit
                 (expense)                           $ 5,273,000     4,669,000     23,382,000
             Difference in foreign income tax rate            --            --     (1,568,000)
             Foreign permanent differences                    --            --    (12,353,000)
             Change in valuation allowance            (2,200,000)   (4,119,000)   (15,750,000)
             Other                                      (434,000)     (571,000)      (659,000)
                                                     -----------    ----------    -----------

                                                     $ 2,639,000       (21,000)    (6,948,000)
                                                     ===========    ==========    ===========
</TABLE>

       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. Based upon the weight of
       available evidence, the Company establishes a valuation allowance to
       reduce the amount of deferred tax assets to the amount it believes will
       more likely than not be realized in future periods. Significant
       components of the Company's deferred tax assets (liabilities) at May 31
       are as follows:

<TABLE>
<CAPTION>
                                                                2000          2001
                                                            ------------- -------------
             <S>                                            <C>           <C>
             Deferred tax assets:
                 NOL carryforward                           $ 6,493,000    11,931,000
                 Unrealized capital loss carryforward         1,550,000     1,557,000
                 Goodwill                                     2,408,000     3,229,000
                 Fixed asset write-off                          540,000     3,507,000
                 Inventory reserve                              502,000     1,397,000
                 Other                                          387,000       566,000
                 Valuation allowances                        (6,322,000)  (22,072,000)
                                                            ------------- -------------

                                                              5,558,000       115,000
                                                            ------------- -------------

             Deferred tax liabilities - depreciation:
                 Domestic                                     1,745,000     1,227,000
                 International                                  638,000       850,000
                                                            ------------- -------------

                                                              2,383,000     2,077,000
                                                            ------------- -------------

                        Net deferred tax asset (liability)  $ 3,175,000    (1,962,000)
                                                            ============= =============

</TABLE>

                                                                     (Continued)

                                      80
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

       The Company has net operating loss (NOLs) carryforwards for U.S. federal
       income tax purposes of approximately $38.1 million, the benefits of which
       expire in the tax year 2002 through the tax year 2021.

       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 $2.0 million of the $38.1 million total NOLs at May 31,
       2001 will never become available.


(20)   Net Loss Per Share

       Basic net loss per share is computed on the basis of the weighted average
       number of common shares outstanding. Diluted net 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 loss per share at May 31 were as
       follows:

<TABLE>
<CAPTION>
                                                          1999           2000            2001
                                                     ------------    -----------    ------------
<S>                                                  <C>             <C>            <C>
      Net loss available for common shareholders      (12,869,000)   (13,049,000)   (75,720,000)
                                                     ============    ===========    ============
      Average outstanding shares of common stock       17,359,491     21,955,473     35,283,347

      Dilutive effect of:
          Warrants                                             --             --             --
          Stock options                                        --             --             --
                                                     ------------    -----------    ------------
      Common stock and common stock equivalents        17,359,491     21,955,473     35,283,347
                                                     ============    ===========    ============
      Net loss per share:
          Basic                                             (0.74)         (0.59)         (2.15)
          Diluted                                           (0.74)         (0.59)         (2.15)
</TABLE>

       Options, warrants and convertible stock were not included in the
       calculation of net loss per share as they are anti-dilutive. The total
       number of anti-dilutive options and warrants as of May 31, 2001 was
       11,607,787.

                                      81
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001


(21)   Fair Value of Financial Instruments

       The Company's financial instruments include cash and cash equivalents,
       receivables, 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
       50% of face value.


(22)   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.


(23)   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.

                                      82
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001


(a) 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 (deficit)           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
                                                   ============    =============   =============   =============   =============
</TABLE>

                                                                     (Continued)

                                      83
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

(b) Consolidating condensed balance sheet information at May 31, 2001 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                             $  1,134,000         3,000     2,958,000            --     4,095,000
        Accounts receivable, net                                        --     6,423,000    12,839,000      (161,000)   19,101,000
        Inventories                                                     --    14,326,000     8,668,000            --    22,994,000
        Other                                                    3,975,000       299,000       401,000    (3,894,000)      781,000
                                                              ------------- ------------- ------------- ------------- -------------
                 Total current assets                            5,109,000    21,051,000    24,866,000    (4,055,000)   46,971,000
                                                              ------------- ------------- ------------- ------------- -------------
    Property, plant and equipment, net                           5,319,000    11,882,000     9,553,000            --    26,754,000
                                                              ------------- ------------- ------------- ------------- -------------
    Other assets:
        Costs in excess of net book value of acquired
           subsidiaries, net                                            --       351,000            --            --       351,000
        Investment in and loans to subsidiaries                 41,943,000    72,618,000            --  (114,561,000)           --
        Other                                                    5,699,000     1,041,000            --            --     6,740,000
                                                              ------------- ------------- ------------- ------------- -------------
                 Total other assets                             47,642,000    74,010,000            --  (114,561,000)    7,091,000
                                                              ------------- ------------- ------------- ------------- -------------
                 Total assets                                 $ 58,070,000   106,943,000    34,419,000  (118,616,000)   80,816,000
                                                              ============= ============= ============= ============= =============

              Liabilities and Stockholders' Equity (Deficit)
    Current liabilities:
        Accounts payable                                      $    921,000     5,328,000     6,551,000      (161,000)   12,639,000
        Current portion of long-term debt                           90,000       839,000            --            --       929,000
        Other                                                    3,413,000     2,351,000     6,499,000    (3,894,000)    8,369,000
                                                              ------------- ------------- ------------- ------------- -------------
                 Total current liabilities                       4,424,000     8,518,000    13,050,000    (4,055,000)   21,937,000
                                                              ------------- ------------- ------------- ------------- -------------
    Long-term liabilities:
        Long-term debt, net of current portion                  78,635,000     2,034,000            --            --    80,669,000
        Intercompany loan payable                                       --    71,723,000    36,957,000  (108,680,000)           --
        Other                                                      125,000     1,880,000     1,319,000            --     3,324,000
                                                              ------------- ------------- ------------- ------------- -------------
                 Total long-term liabilities                    78,760,000    75,637,000    38,276,000  (108,680,000)   83,993,000
                                                              ------------- ------------- ------------- ------------- -------------
    Stockholders' equity (deficit):
        Common stock                                                39,000    56,139,000    33,709,000   (89,848,000)       39,000
        Additional paid-in capital                              86,917,000            --            --            --    86,917,000
        Accumulated other comprehensive loss                    (9,165,000)           --    (9,165,000)    9,165,000    (9,165,000)
        Accumulated deficit                                   (102,905,000)  (33,351,000)  (41,451,000)   74,802,000  (102,905,000)
                                                              ------------- ------------- ------------- ------------- -------------
                 Total stockholders' equity (deficit)          (25,114,000)   22,788,000   (16,907,000)   (5,881,000)  (25,114,000)
                                                              ------------- ------------- ------------- ------------- -------------
                 Total liabilities and stockholders' equity   $ 58,070,000   106,943,000    34,419,000  (118,616,000)   80,816,000
                                                              ============= ============= ============= ============= =============
                                                                                                                        (Continued)
</TABLE>

                                      84
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001



(c) 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)
                                                       =============   ============    =============   ============   ============
</TABLE>

(d) 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)
                                                       =============   ============    =============   ============   ============
</TABLE>

                                                                     (Continued)

                                      85
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001

(e)  Consolidating condensed statement of operations information for the year
     ended May 31, 2001 is as follows:

<TABLE>
<CAPTION>
                                                                   Guarantor       Non-guarantor
                                                    Parent        subsidiaries      subsidiaries     Eliminations     Consolidated
                                                 ------------     ------------     -------------    -------------   ----------------
      <S>                                         <C>             <C>              <C>              <C>             <C>
      Net sales                                  $         --      59,943,000        51,597,000       (2,252,000)     109,288,000
      Cost of sales                                        --      57,428,000        45,872,000       (2,252,000)     101,048,000
                                                 ------------     ------------     -------------    -------------   ----------------
                     Gross profit                          --       2,515,000         5,725,000               --        8,240,000

      Operating expenses                            7,336,000      25,687,000        40,965,000       (6,787,000)      67,201,000
                                                 ------------     ------------     -------------    -------------   ----------------

                     Loss from operations          (7,336,000)    (23,172,000)      (35,240,000)       6,787,000      (58,961,000)
                                                 ------------     ------------     -------------    -------------   ----------------
      Other income (expense):
         Parent's share of subsidiaries net loss  (65,172,000)             --                --       65,172,000               --
         Interest expense                          (9,423,000)     (4,416,000)       (3,976,000)       7,788,000      (10,027,000)
         Other                                     10,536,000       4,247,000             8,000      (14,575,000)         216,000
                                                 ------------     ------------     -------------    -------------   ----------------
                     Total other expense          (64,059,000)       (169,000)       (3,968,000)      58,385,000       (9,811,000)
                                                 ------------     ------------     -------------    -------------   ----------------
                     Loss before income taxes     (71,395,000)    (23,341,000)      (39,208,000)      65,172,000      (68,772,000)

      Income tax expense                           (4,325,000)       (641,000)       (1,982,000)              --       (6,948,000)
                                                 ------------     ------------     -------------    -------------   ----------------
                     Net loss                     (75,720,000)    (23,982,000)      (41,190,000)      65,172,000      (75,720,000)

      Other comprehensive loss - foreign
         currency translation                      (2,915,000)             --        (2,915,000)       2,915,000       (2,915,000)
                                                 ------------     ------------     -------------    -------------   ----------------
                     Comprehensive loss          $(78,635,000)    (23,982,000)      (44,105,000)      68,087,000      (78,635,000)
                                                 ============     ============     =============    =============   ================
</TABLE>

                                                                     (Continued)

                                      86
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001


(f) 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
</TABLE>

                                                                     (Continued)

                                      87
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements

                             May 31, 2000 and 2001


(g) 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            (1,311,000)         (39,000)               --             --    (1,350,000)
     Other changes, net                                  2,263,000           21,000            85,000     (3,825,000)   (1,456,000)
                                                    --------------   --------------   ---------------   ------------   -----------
       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 common stock                11,457,000               --                --             --    11,457,000
</TABLE>

                                                                    (Continued)

                                      88
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements
                             May 31, 2000 and 2001

(h)  Consolidating condensed statement of cash flows information for the year
     ended May 31, 2001 is as follows:

<TABLE>
<CAPTION>
                                                                                                    Guarantor        Non-guarantor
                                                                                   Parent          subsidiaries       subsidiaries
                                                                              ---------------   ----------------   ----------------
<S>                                                                           <C>               <C>                <C>
     Cash flow from operating activities - net cash provided
        by (used in) operating activities                                     $    (5,824,000)         2,011,000          2,213,000
                                                                              ---------------   ----------------   ----------------
     Cash flow from investing activities:
        Acquisition of property, plant and equipment                                 (458,000)        (1,141,000)        (2,111,000)
        Proceeds from sale of property, plant and equipment                           913,000          1,341,000                 --
        Investment in and loans to subsidiaries                                       (12,000)                --                 --
        Other changes, net                                                                 --            (20,000)                --
                                                                              ---------------   ----------------   ----------------
                    Net cash provided by (used in)
                       investing activities                                           443,000            180,000         (2,111,000)
                                                                              ---------------   ----------------   ----------------
     Cash flow from financing activities:
        Net borrowings under line of credit                                           307,000                 --             12,000
        Payments on long-term debt and capital leases                                (277,000)        (1,284,000)          (137,000)
        Proceeds from long-term debt                                                4,802,000                 --                 --
        Proceeds from sale of common stock and warrants, net                        1,863,000                 --                 --
        Other changes, net                                                              4,000           (962,000)           974,000
                                                                              ---------------   ----------------   ----------------
                    Net cash provided by (used in)
                      financing activities                                          6,699,000         (2,246,000)           849,000
                                                                              ---------------   ----------------   ----------------
                    Net change in cash and cash equivalents                         1,318,000            (55,000)           951,000

     Cash and cash equivalents at beginning of year                                  (184,000)            58,000          2,280,000
                                                                              ---------------   ----------------   ----------------
     Effect of exchange rates on cash                                                      --                 --           (273,000)
                                                                              ---------------   ----------------   ----------------
     Cash and cash equivalents at end of year                                 $     1,134,000              3,000          2,958,000
                                                                              ===============   ================   ================
     Supplemental cash flow:
        Noncash operating expenses related to:
           Depreciation                                                       $       557,000          3,236,000          2,450,000
           Amortization                                                                    --            361,000            730,000
        Cash paid during the year for:
           Interest                                                                 7,920,000            522,000             82,000
           Income taxes                                                                    --                 --            295,000
        Noncash investing and financing activities - short-term
           obligations refinanced with long-term debt                               9,306,000                 --                 --
        Issuance of warrants in connection with debt                                1,886,000                 --                 --

<CAPTION>
                                                                               Eliminations                Consolidated
                                                                              ---------------            -----------------
<S>                                                                           <C>                        <C>
     Cash flow from operating activities - net cash provided
        by (used in) operating activities                                                  --                  (1,600,000)
                                                                              ---------------            -----------------
     Cash flow from investing activities:
        Acquisition of property, plant and equipment                                       --                  (3,710,000)
        Proceeds from sale of property, plant and equipment                                --                   2,254,000
        Investment in and loans to subsidiaries                                        12,000                          --
        Other changes, net                                                                 --                     (20,000)
                                                                              ---------------            -----------------
                    Net cash provided by (used in)
                       investing activities                                            12,000                  (1,476,000)
                                                                              ---------------            -----------------
     Cash flow from financing activities:
        Net borrowings under line of credit                                                --                     319,000
        Payments on long-term debt and capital leases                                      --                  (1,698,000)
        Proceeds from long-term debt                                                       --                   4,802,000
        Proceeds from sale of common stock and warrants, net                               --                   1,863,000
        Other changes, net                                                            (12,000)                      4,000
                                                                              ---------------            -----------------
                    Net cash provided by (used in)
                      financing activities                                            (12,000)                  5,290,000
                                                                              ---------------            -----------------
                    Net change in cash and cash equivalents                                --                   2,214,000

     Cash and cash equivalents at beginning of year                                        --                   2,154,000

     Effect of exchange rates on cash                                                      --                    (273,000)
                                                                              ---------------            -----------------
     Cash and cash equivalents at end of year                                              --                   4,095,000
                                                                              ===============            =================

     Supplemental cash flow:
        Noncash operating expenses related to:
           Depreciation                                                                    --                   6,243,000
           Amortization                                                                    --                   1,091,000
        Cash paid during the year for:
           Interest                                                                        --                   8,524,000
           Income taxes                                                                    --                     295,000
        Noncash investing and financing activities - short-term
           obligations refinanced with long-term debt                                      --                   9,306,000
        Issuance of warrants in connection with debt                                       --                   1,886,000
</TABLE>
                                                                     (Continued)

                                      89
<PAGE>

                     PACIFIC AEROSPACE & ELECTRONICS, INC.
                               AND SUBSIDIARIES

                  Notes to Consolidated Financial Statements
                             May 31, 2000 and 2001

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

<TABLE>
<CAPTION>
                                                                               2000                   2001
                                                                       -------------------    -------------------
<S>                                                                    <C>                    <C>
                 Guarantor subsidiaries
                     Raw materials                                     $      5,492,000              3,594,000
                     Work in progress                                         5,439,000              4,045,000
                     Finished goods                                           6,376,000              6,687,000
                                                                       ----------------       ----------------
                                                                             17,307,000             14,326,000
                                                                       ----------------       ----------------
                 Non-guarantor subsidiaries:
                     Raw materials                                            1,712,000              1,438,000
                     Work in progress                                         8,142,000              6,945,000
                     Finished goods                                             688,000                285,000
                                                                       ----------------       ----------------
                                                                             10,542,000              8,668,000
                                                                       ----------------       ----------------
                               Total inventories                    $        27,849,000             22,994,000
                                                                       ================       ================
</TABLE>

(24)  Subsequent Event

      Effective June 1, 2001, the Company sold substantially all of the assets
      of the U.S. Aerospace Group's Casting Division located in Entiat,
      Washington to two newly formed limited liability companies owned by a
      private company. The purchase price was approximately $4.6 million, which
      consisted of approximately $1.5 million cash, a $1.0 million long-term
      note payable to the Company, units in the newly created limited liability
      companies valued at $1.0 million and the assumption of $1.1 million in
      liabilities. The Company used the cash proceeds to retire certain
      long-term debt related to the Entiat assets and to pay closing costs
      related to the transaction. The long-term note bears interest at 7% and
      is payable in quarterly installments, interest only for the first year
      and then principal and interest for 5 additional years. Due to the
      uncertainties of payment under this note, the Company has fully reserved
      against it as of the closing date. The units in the newly created limited
      liability companies have certain preferential rights including an
      accumulating preferred return equal to 5% of the par value of then
      outstanding units and put rights subject to certain restrictions and
      limitations. Due to the inability to accurately estimate and uncertainty
      surrounding the fair market value of the units, the Company has assigned
      no value to the units for financial statement purposes.

                                      90
<PAGE>

ITEM 8A.  SELECTED QUARTERLY FINANCIAL DATA

The following selected quarterly financial data presents selected historical
financial data of the Company as of the quarterly periods ended, as indicated,
and is derived from our unaudited consolidated quarterly financial statements.
This data should be read in conjunction with our Consolidated Financial
Statements and Notes thereto, the Independent Auditor's Report, and Management's
Discussion and Analysis of Financial Condition and Results of Operations. The
Independent Auditor's Report contains an explanatory paragraph that states that
our recurring losses from operations raise substantial doubt about our ability
to continue as a going concern. The independent auditors' report for the fiscal
year 2001 is a disclaimer of opinion. Our Consolidated Financial Statements and
the following selected quarterly financial data do not include any adjustments
that might result from the outcome of that uncertainty.


                     Pacific Aerospace & Electronics, Inc.
                       Selected Quarterly Financial Data
                            For the Quarters Ended,
                     (in thousands, except per share data)

<TABLE>
<CAPTION>
                                  August 31,  November 30,  February 29,  May 31,  August 31,  November 30,  February 28,  May 31,
                                     1999        1999          2000        2000       2000        2000          2001        2001
                                     ----        ----          ----        ----       ----        ----          ----        ----
<S>                               <C>         <C>           <C>           <C>      <C>         <C>           <C>          <C>
Net Sales                         $   28,571     29,000       26,501      28,622      27,643      27,437       27,068      27,140

Gross profit                           6,560      5,251        5,146       3,674       4,922       3,086         (925)      1,157

Loss before extraordinary item        (1,506)    (2,014)      (1,675)     (8,557)     (2,252)     (4,943)     (40,341)    (28,184)

Net loss                              (1,506)    (2,014)      (1,675)     (7,854)     (2,252)     (4,943)     (40,341)    (28,184)

Net loss per share:
    Basic                              (0.08)     (0.10)       (0.08)      (0.28)      (0.07)      (0.14)       (1.32)      (0.73)
    Diluted                            (0.08)     (0.10)       (0.08)      (0.28)      (0.07)      (0.14)       (1.32)      (0.73)

Shares used in computation of
loss per share (in thousands):
    Basic                             19,108     19,992       21,043      27,634      33,114      34,292       35,020      38,692
    Diluted                           19,108     19,992       21,043      27,634      33,114      34,292       35,020      38,692
</TABLE>

                                      91
<PAGE>

During the quarter ended May 31, 2000, due to continuing losses and continued
weakness in the commercial aerospace and transportation industries, we realized
a $4.6 million impairment of goodwill and a $600,000 property impairment related
to our U.S. Aerospace Group.

During the quarter ended May 31, 2000, we exchanged an aggregate of $11.3
million in original principal amount of our 11 1/4% senior subordinated debt 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 was
recorded in the accompanying selected quarterly financial data as an
extraordinary item.

During the quarter ended November 30, 2000, we recognized a $0.7 million
impairment charge to reduce the carrying value of the equipment located at the
Tacoma, Washington location of our U.S. Aerospace Group's Casting Division to
its estimated net realizable value. We also recognized a $320,000 non-cash
charge for the loss on the sale of an unused building in Butler, New Jersey. Net
proceeds from the sale of the building were approximately $660,000, versus a
carrying amount of approximately $980,000.

During the quarter ended February 28, 2001, based upon preliminary and final
offers to purchase our European Aerospace Group, we recognized a $25.0 million
charge to reduce the $33.0 million carrying value of goodwill associated with
our European Aerospace Group to net estimated realizable value. We also
recognized an impairment charge of $3.5 million to reduce the value of property
and equipment used at the Entiat, Washington location of our U.S. Aerospace
Group's Casting Division to net realizable value. We recognized a non-cash
charge of approximately $3.3 million to reduce the carrying value of goodwill
and equipment used in the U.S. Aerospace Group's Engineering & Fabrication
Division to estimated liquidation value. Finally, within the U.S. Electronics
Group's Display Division, we recognized a non-cash charge of approximately $0.6
million to reduce the carrying value of equipment used to produce low power
relays to its net realizable value.

During the quarter ended May 31, 2001, based upon preliminary and final offers
to purchase our European Aerospace Group, we recognized a additional $12.0
million charge to reduce the carrying value of goodwill and equipment associated
with our European Aerospace Group to net estimated realizable value. We also
recognized an additional impairment charge of $2.0 million to reduce the value
of property and equipment used at the Entiat, Washington location of our U.S.
Aerospace Group's Casting Division to its estimated net realizable value and an
additional impairment charge of $0.1 million to reduce the carrying value of the
equipment located at the division's Tacoma location to its estimated net
realizable value. During the fourth quarter of fiscal 2001, we also completed
our analysis of the value of certain other long-lived assets, including goodwill
and patents. Based upon this analysis, we recognized additional impairment
charges of approximately $1.0 million to reduce goodwill to estimated fair
value, and approximately $0.3 million to reduce patents to estimated fair value.

                                      92
<PAGE>

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

None.

                                      93
<PAGE>

                                   PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY

Directors and Executive Officers

On August 15, 2001, Nick A. Gerde, who served as Vice President Finance and
Chief Financial Officer of the Company, as well as Treasurer and Assistant
Secretary, left his employment with the Company. Charles A. Miracle, who
previously served as Corporate Controller, took on the role of Interim Chief
Financial Officer and Treasurer of the Company on that date.

The information regarding directors and executive officers required by Item 10
is incorporated by reference from the Company's definitive proxy statement for
its 2001 annual meeting of shareholders. The proxy statement will be filed on or
prior to September 28, 2001.

ITEM 11.  Executive Compensation

The information required by Item 11 is incorporated by reference to the
Company's definitive proxy statement for its 2001 annual meeting of
shareholders. The proxy statement will be filed on or prior to September 28,
2001. The information specified in Item 402 (k) and (l) of Regulation S-K and to
be set forth in the Company's definitive proxy statement for its 2001 annual
meeting of shareholders is not incorporated herein by reference.

ITEM 12.  Security Ownership of Certain Beneficial Owners and Management

The information required by Item 12 is incorporated by reference to the
Company's definitive proxy statement for its 2001 annual meeting of
shareholders. The proxy statement will be filed on or prior to September 28,
2001.

ITEM 13.  Certain Relationships and Related Transactions

The information required by Item 13 is incorporated by reference to the
Company's definitive proxy statement for its 2001 annual meeting of
shareholders. The proxy statement will be filed on or prior to September 28,
2001.

                                      94
<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 27, 2001
         Consolidated Balance Sheets as of May 31, 2000 and 2001
         Consolidated Statements of Operations and Comprehensive Loss for the
             years ended May 31, 1999, 2000 and 2001
         Consolidated Statements of Stockholders' Equity (Deficit) for the years
             ended May 31, 1999, 2000 and 2001
         Consolidated Statements of Cash Flows for the years ended May 31, 1999,
             2000 and 2001
         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        Asset Purchase Agreement between Aeromet America, Inc., Pacific
           Aerospace & Electronics, Inc., U.S. Castings, LLC, USCRE Properties,
           LLC, and Advanced Aluminum, LLC, dated June 14, 2001. /(42)/
2.2        Closing Agreement between Aeromet America, Inc., Pacific Aerospace &
           Electronics, Inc., U.S. Castings, LLC, USCRE Properties, LLC, and
           Advanced Aluminum, LLC, dated June 14, 2001. /(42)/
2.3        Asset Purchase Agreement between MCE Technologies Incorporated and
           Skagit Engineering & Manufacturing, Inc., dated May 4, 2001. /(43)/
2.4        Agreement for Purchase and Sale of Assets between Teledyne
           Technologies Incorporated and Electronic Specialty Corporation, dated
           February 21, 2001. /(43)/
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)/
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)/

                                      95
<PAGE>

  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      Warrant Agreement between Interwest Transfer Co., Inc. and PCT
           Holdings, Inc. dated July 1, 1996./(4)/
  4.7      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)/
  4.8      Common Stock Purchase Warrant No. 001 from Pacific Aerospace &
           Electronics, Inc. to Donald A. Wright dated as of November 30,
           1996./(10)/
  4.9      Common Stock Purchase Warrant No. 002 from Pacific Aerospace &
           Electronics, Inc. to Nick A. Gerde dated as of November 30, 1996.
           /(10)/
  4.10     Common Stock Purchase Warrant No. 003 from Pacific Aerospace &
           Electronics, Inc. to Edward A. Taylor dated as of November 30,
           1996./(10)/
  4.11     Common Stock Purchase Warrant from Pacific Aerospace & Electronics,
           Inc. to Gregory K. Smith dated June 3, 1997./(9)/
  4.12     Common Stock Purchase Warrant from Pacific Aerospace & Electronics,
           Inc. to Nestor Wiegand dated June 3, 1997./(9)/
  4.13     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)/
  4.14     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)/
  4.15     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 & Tru st Company./(18)/
  4.16     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., Inc. and BancBoston Securities Inc./(18)/
  4.17     Form of Global Note by Pacific Aerospace & Electronics, Inc./(18)/
  4.18     Form of Subsidiary Guaranty from the U.S. subsidiaries of Pacific
           Aerospace & Electronics, Inc./(25)/
  4.19     Securities Purchase Agreement among Pacific Aerospace & Electronics,
           Inc., Strong River Investments, Inc., and Bay Harbor Investments,
           Inc., dated as of July 27, 2000./(33)/
  4.20     Registration Rights Agreement between Pacific Aerospace &
           Electronics, Inc., Strong River Investments, Inc., and Bay Harbor
           Investments, Inc., dated as of July 27, 2000./(33)/
  4.21     Warrant between Pacific Aerospace & Electronics, Inc. and Strong
           River Investments, Inc., dated as of July 27, 2000./(33)/
  4.22     Warrant between Pacific Aerospace & Electronics, Inc. and Bay Harbor
           Investments, Inc., dated as of July 27, 2000./(33)/
  4.23     Warrant between Pacific Aerospace & Electronics, Inc. and Strong
           River Investments, Inc., dated as of July 27, 2000./(33)/

                                      96
<PAGE>

  4.24     Warrant between Pacific Aerospace & Electronics, Inc. and Bay Harbor
           Investments, Inc., dated as of July 27, 2000./(33)/
  4.25     Vesting Warrant between Pacific Aerospace & Electronics, Inc. and
           Strong River Investments, Inc., dated as of July 27, 2000./(33)/
  4.26     Vesting Warrant between Pacific Aerospace & Electronics, Inc. and Bay
           Harbor Investments, Inc., dated as of July 27, 2000./(33)/
  4.27     Letter agreement among Pacific Aerospace & Electronics, Inc., Strong
           River Investments, Inc. and Bay Harbor Investments, Inc., dated as of
           February 15, 2001./(40)/
  4.28     Placement Agent Warrant between Pacific Aerospace & Electronics, Inc.
           and Rochon Capital Group, Ltd., dated as of July 27, 2000./(34)/
  4.29     Common Stock Purchase Warrant between Pacific Aerospace &
           Electronics, Inc. and Continental Capital & Equity Corporation, dated
           April 17, 2000./(34)/
  4.30     Common Stock Purchase Warrant between Pacific Aerospace &
           Electronics, Inc. and Continental Capital & Equity Corporation, dated
           April 17, 2000./(34)/
  4.31     Common Stock Purchase Warrant between Pacific Aerospace &
           Electronics, Inc. and Continental Capital & Equity Corporation, dated
           April 17, 2000./(34)/
  4.32     Common Stock Purchase Warrant between Pacific Aerospace &
           Electronics, Inc. and Continental Capital & Equity Corporation, dated
           April 17, 2000./(34)/
  4.33     Loan Agreement, by and among Pacific Aerospace & Electronics, Inc.,
           Aeromet America, Inc., Balo Precision Parts, Inc., Cashmere
           Manufacturing Co., Inc., Ceramic Devices, Inc., Electronic Specialty
           Corporation, Northwest Technical Industries, Inc., Pacific Coast
           Technologies, Inc., Seismic Safety Products, Inc., Skagit Engineering
           & Manufacturing, Inc. and PA&E International, Inc., as Borrowers,
           Pacific A&E Limited, Pacific Aerospace & Electronics (UK) Limited,
           Aeromet International PLC, the Foreign Subsidiaries, and DDJ Capital
           Management, LLC, as Agent for the Lenders, dated March 1, 2001./(41)/
  4.34     Term Loan Note, executed by Pacific Aerospace & Electronics, Inc.,
           Aeromet America, Inc., Balo Precision Parts, Inc., Cashmere
           Manufacturing Co., Inc., Ceramic Devices, Inc., Electronic Specialty
           Corporation, Northwest Technical Industries, Inc., Pacific Coast
           Technologies, Inc., Seismic Safety Products, Inc., Skagit Engineering
           & Manufacturing, Inc. and PA&E International, Inc. in favor of B III
           Capital Partners, L.P., dated March 1, 2001, in the amount of
           $6,459,361.00./(41)/
  4.35     Term Loan Note, executed by Pacific Aerospace & Electronics, Inc.,
           Aeromet America, Inc., Balo Precision Parts, Inc., Cashmere
           Manufacturing Co., Inc., Ceramic Devices, Inc., Electronic Specialty
           Corporation, Northwest Technical Industries, Inc., Pacific Coast
           Technologies, Inc., Seismic Safety Products, Inc., Skagit Engineering
           & Manufacturing, Inc. and PA&E International, Inc. in favor of B III-
           A Capital Partners, L.P., dated March 1, 2001, in the amount of
           $2,768,298.00./(41)/

                                      97
<PAGE>

  4.36     Term Loan Note, executed by Pacific Aerospace & Electronics, Inc.,
           Aeromet America, Inc., Balo Precision Parts, Inc., Cashmere
           Manufacturing Co., Inc., Ceramic Devices, Inc., Electronic Specialty
           Corporation, Northwest Technical Industries, Inc., Pacific Coast
           Technologies, Inc., Seismic Safety Products, Inc., Skagit Engineering
           & Manufacturing, Inc. and PA&E International, Inc. in favor of DDJ
           Canadian High Yield Fund, dated March 1, 2001, in the amount of
           $1,845,531.00./(41)/
  4.37     Term Loan Note, executed by Pacific Aerospace & Electronics, Inc.,
           Aeromet America, Inc., Balo Precision Parts, Inc., Cashmere
           Manufacturing Co., Inc., Ceramic Devices, Inc., Electronic Specialty
           Corporation, Northwest Technical Industries, Inc., Pacific Coast
           Technologies, Inc., Seismic Safety Products, Inc., Skagit Engineering
           & Manufacturing, Inc. and PA&E International, Inc. in favor of State
           Street Bank & Trust, as Custodian for General Motors Employees Global
           Group Pension Trust, dated March 1, 2001, in the amount of
           $2,768,298.00./(41)/
  4.38     Security Agreement, by and among Pacific Aerospace & Electronics,
           Inc., Aeromet America, Inc., Balo Precision Parts, Inc., Cashmere
           Manufacturing Co., Inc., Ceramic Devices, Inc., Electronic Specialty
           Corporation, Northwest Technical Industries, Inc., Pacific Coast
           Technologies, Inc., Seismic Safety Products, Inc., Skagit Engineering
           & Manufacturing, Inc. and PA&E International, Inc. and DDJ Capital
           Management, LLC, as Agent for the Lenders, dated March 1, 2001./(41)/
  4.39     Intellectual Property Security Agreement, by and among Pacific
           Aerospace & Electronics, Inc., Aeromet America, Inc., Balo Precision
           Parts, Inc., Cashmere Manufacturing Co., Inc., Ceramic Devices, Inc.,
           Electronic Specialty Corporation, Northwest Technical Industries,
           Inc., Pacific Coast Technologies, Inc., Seismic Safety Products,
           Inc., Skagit Engineering & Manufacturing, Inc. and PA&E
           International, Inc. and DDJ Capital Management, LLC, as Agent for the
           Lenders, dated March 1, 2001./(41)/
  4.40     Pledge Agreement, by and among Pacific Aerospace & Electronics, Inc.,
           Aeromet America, Inc., Balo Precision Parts, Inc., Cashmere
           Manufacturing Co., Inc., Ceramic Devices, Inc., Electronic Specialty
           Corporation, Northwest Technical Industries, Inc., Pacific Coast
           Technologies, Inc., Seismic Safety Products, Inc., Skagit Engineering
           & Manufacturing, Inc., PA&E International, Inc., Pacific A&E Limited,
           Pacific Aerospace & Electronics (UK) Limited, Aeromet International
           PLC, and DDJ Capital Management, LLC, as Agent for the Lenders, dated
           March 1, 2001./(41)/
  4.41     Warrant Agreement, by and among Pacific Aerospace & Electronics, Inc.
           and Holders, dated March 1, 2001./(41)/
  4.42     Warrant Certificate, dated March 1, 2001, issued to B III Capital
           Partners, L.P., exercisable for 1,883,923 shares of Common Stock.
           /(41)/
  4.43     Warrant Certificate, dated March 1, 2001, issued to B III-A Capital
           Partners, L.P., exercisable for 807,396 shares of Common Stock./(41)/
  4.44     Warrant Certificate, dated March 1, 2001, issued to DDJ Canadian High
           Yield Fund, exercisable for 538,263 shares of Common Stock./(41)/
  4.45     Warrant Certificate, dated March 1, 2001, issued to State Street Bank
           & Trust, as Custodian for General Motors Employees Global Group
           Pension Trust, exercisable for 807,396 shares of Common Stock./(41)/
  4.46     Equity Registration Rights Agreement, by and among Pacific Aerospace
           & Electronics, Inc. and Holders, dated March 1, 2001./(41)/
  4.47     Warrant Agreement by and among Pacific Aerospace & Electronics, Inc.
           and First Albany Corporation, dated April 9, 2001./(43)/
  4.48     Warrant Certificate, dated April 9, 2001, issued to First Albany
           Corporation, exercisable for 692,074 shares of Common Stock./(43)/

                                      98
<PAGE>

  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     Amendment No. 2 to Employment Agreement, dated June 1, 2001, between
           Pacific Aerospace & Electronics, Inc. and Donald A. Wright./(43)/
  10.9     Employment Agreement, dated March 1, 1999, between Pacific Aerospace
           & Electronics, Inc. and Werner Hafelfinger./(27)/
  10.10    Amendment No. 1 to Employment Agreement dated June 1, 2001, between
           Pacific Aerospace & Electronics, Inc. and Werner Hafelfinger/(43)/
  10.11    Employment Agreement, dated June 1, 1997, between Pacific Aerospace &
           Electronics, Inc. and Nick A. Gerde./(9)/
  10.12    Amendment No. 1 to Employment Agreement dated June 1, 2001, between
           Pacific Aerospace & Electronics, Inc. and Nick A. Gerde./(43)/
  10.13    Separation Letter dated August 15, 2001 from Pacific Aerospace &
           Electronics, Inc. to Nick A. Gerde./(43)/
  10.14    Waiver and Release dated August 17, 2001 from Nick A. Gerde to
           Pacific Aerospace & Electronics, Inc./(43)/
  10.15    Employment Agreement, dated September 1, 1997, between Pacific
           Aerospace & Electronics, Inc. and Sheryl A. Symonds./(12)/
  10.16    Amendment No. 1 to Employment Agreement dated June 1, 2001, between
           Pacific Aerospace & Electronics, Inc. and Sheryl A. Symonds./(43)/
  10.17    Incentive Compensation Program./(35)/
  10.18    Promissory Note, dated March 18, 1998, from Pacific Aerospace &
           Electronics, Inc. to KeyBank National Association./(15)/
  10.19    Security Agreement, dated March 18, 1998, from Pacific Aerospace &
           Electronics, Inc. to KeyBank National Association./(15)/
  10.20    Loan Agreement, dated September 7, 1999, between Pacific Aerospace &
           Electronics, Inc. and KeyBank National Association./(29)/
  10.21    Promissory Note, dated September 22, 1998, from Pacific Aerospace &
           Electronics, Inc. to KeyBank National Association./(22)/
  10.22    Commercial Security Agreement, dated September 7, 1999, between
           Pacific Aerospace & Electronics, Inc. and KeyBank National
           Association./(29)/
  10.23    Promissory Note, dated September 30, 1998, from Pacific Aerospace &
           Electronics, Inc. to KeyBank National Association./(22)/
  10.24    Deed of Trust, dated September 30, 1998, between Pacific Aerospace &
           Electronics, Inc., KeyBank National Association and Land Title
           Company, Chelan-Douglas County, Inc./(22)/
  10.25    Modification and/or Extension Agreement, dated October 6, 1999,
           between Pacific Aerospace & Electronics, Inc. and KeyBank National
           Association /(29)/
  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)/

                                      99
<PAGE>

  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)/
  10.30   Modification and/or Extension Agreement dated February 7, 2001,
          between Pacific Aerospace & Electronics, Inc. and KeyBank National
          Association./(39)/
  10.31   Letter dated April 11, 2001 to Pacific Aerospace & Electronics, Inc.
          from Special Assets Group of Key Bank Washington./(43)/
  10.32   Facility Letter, dated July 30, 1998, from Barclays Bank plc to
          Aeromet International plc./(20)/
  10.33   Non-Negotiable Promissory Note in the original principal amount of
          $1,000,000.00, from U.S. Castings, LLC to Pacific Aerospace &
          Electronics, Inc., dated June 14, 2001./(42)/
  10.34   Guarantee by USCRE Properties, LLC to Pacific Aerospace &
          Electronics, Inc., dated June 14, 2001./(42)/
  10.35   Escrow Note in the original principal amount of $160,000.00, from
          U.S. Castings, LLC and USCRE Properties, LLC to Pacific Aerospace &
          Electronics, Inc., dated June 14, 2001./(42)/
  10.36   U.S. Castings, LLC Limited Liability Company Agreement, dated June
          13, 2001./(42)/
  10.37   First Amendment to U.S. Castings, LLC Limited Liability Company
          Agreement, dated June 14, 2001./(42)/
  10.38   USCRE Properties, LLC Limited Liability Company Agreement, dated June
          13, 2001./(42)/
  10.39   First Amendment to USCRE Properties, LLC Limited Liability Company
          Agreement, dated June 14, 2001./(42)/
  10.40   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)/
  10.41   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 Aer ospace Group)./(1)/ /(31)/
  10.42   Option to Purchase, dated January 29, 1999, between Pacific Aerospace
          & Electronics, Inc. and Donald A. Wright./(27)/
  10.43   Real Estate Agreement, dated January 15, 1999, between Pacific
          Aerospace & Electronics, Inc. and the Port of Chelan County./(27)/
  10.44   Real Estate Purchase and Sale Agreement dated December 29, 2000,
          between Pacific Aerospace & Electronics, Inc. and the Port of Chelan
          County./(37)/
  10.45   Rescission and Termination Agreement, dated July 31, 2001, between
          Pacific Aerospace & Electronics, Inc. and the Port of Chelan County.
          /(43)/
  10.46   Agreement of Sale, dated October 23, 2000 between Balo Precision
          Parts, Inc. and D&G Group II, LLC, Louis E. and Mary E. Giresi
          Grandchildren's Education Trust./(37)/
  21.1    List of Subsidiaries./(43)/
  ---------------
  /(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.
  /(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.

                                      100
<PAGE>

  /(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.
  /(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.

                                      101
<PAGE>

  /(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)/  Incorporated by reference to the Company's Annual Report on Form 10-K
          filed on August 28, 2000.
  /(35)/  Incorporated by reference to the Company's Quarterly Report on Form
          10-Q for the quarterly period ending August 31, 2000.
  /(36)/  Incorporated by reference to the first amendment on Form 10-K/A to the
          Company's Annual Report for the fiscal year ended May 31, 2000, as
          filed on October 13, 2000.
  /(37)/  Incorporated by reference to the Company's Quarterly Report on Form
          10-Q for the quarterly period ending November 30, 2000.
  /(38)/  Incorporated by reference to the second amendment on Form 10-K/A to
          the Company's Annual Report for the fiscal year ended May 31, 2000, as
          filed on January 18, 2001.
  /(39)/  Incorporated by reference to the Company's Current Report on Form 8-K
          filed on February 9, 2001.
  /(40)/  Incorporated by reference to the Company's Current Report on Form 8-K
          filed on February 21, 2001.
  /(41)/  Incorporated by reference to the Company's Current Report on Form 8-K
          filed on March 7, 2001.
  /(42)/  Incorporated by reference to the Company's Current Report on Form 8-K
          filed on June 27, 2001.
  /(43)/  Filed with this report.

  (b)     Reports on Form 8-K. Current reports filed during the last quarter of
fiscal 2001 were as follows:

          (i) The Company filed a Current Report on Form 8-K on March 7, 2001,
reporting the closing of a senior secured loan in the approximate original
principal amount of $13.8 million on March 1, 2001.

          (ii) The Company filed a Current Report on Form 8-K on March 26, 2001,
reporting the receipt on March 22, 2001 of a Nasdaq determination letter
regarding the proposed delisting of the Company's securities.

          (iii) The Company filed a Current Report on Form 8-K on April 2, 2001,
reporting third quarter losses and restructuring plans.

                                      102
<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:  August 29, 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 August 29, 2001.

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

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


/s/ CHARLES A. MIRACLE                   Interim Chief Financial Officer and
--------------------------               Treasurer
CHARLES A. MIRACLE                       (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.

                                      103