<PAGE>

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

                                  FORM 10-K/A

                         (Amendment No. 3 to 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]

<PAGE>

Explanation

This amendment to Form 10-K is filed solely to amend in full Item 8 of the Form
10-K filed on August 29, 2001. All information not specifically amended in this
amendment remains accurate as of date of such information.

                                       2

<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-year 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 1999 and 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 each of the years in the two-year
period ended May 31, 2000, 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

                                       3

<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.

                                        4

<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.

                                       5

<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
                                             ========             ======   ==========    =======   ==========
</TABLE>

<TABLE>
<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
</TABLE>

<PAGE>

<TABLE>
<S>                                                 <C>              <C>              <C>
   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.

                                        6

<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.

                                        7

<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)

                                       8

<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)

                                       9

<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)

                                       10

<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)

                                       11

<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)

                                       12

<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)

                                       13

<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)

                                       14

<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)

                                       15

<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)

                                       16

<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)

                                       17

<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)

                                       18

<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:

                                                           2000          2001
                                                        ----------    ----------
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
                                                       ===========    ==========

     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)

                                       19

<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>
Notepayable 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)

                                       20

<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)

                                       21

<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)

                                       22

<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:


          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
                                                                     ===========

     (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)

                                       23

<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)

                                       24

<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
                                   ==========

                                       25

<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:

                  Warrants outstanding and exercisable
                 ---------------------------------------
                                Weighted
                                 average       Weighted
  Range of                      remaining      average
  Exercise         Number      contractual     exercise
   prices        outstanding       life         price
-------------    -----------   ------------   ----------

$  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
                 ===========


(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.

                                       26

<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.

                                       27

<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:


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


          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.

                                       28

<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>          <C>              <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)

                                       29

<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:

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

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)
                                    =============   ===========   ===========

     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)

                                       30

<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:

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

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)
                                        ===========   ==========   ===========

     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:

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

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)
                                               ===========    ==========

                                                                     (Continued)

                                       31

<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.

                                       32

<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.

                                       33

<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)

                                       34

<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
                                                              Parent        subsidiaries     subsidiaries
                                                           -------------    ------------    -------------
<S>                                                        <C>              <C>              <C>
            Assets

Current assets:
    Cash and cash equivalents                              $   1,134,000           3,000       2,958,000
    Accounts receivable, net                                          --       6,423,000      12,839,000
    Inventories                                                       --      14,326,000       8,668,000
    Other                                                      3,975,000         299,000         401,000
                                                           -------------    ------------     -----------
             Total current assets                              5,109,000      21,051,000      24,866,000
                                                           -------------    ------------     -----------
Property, plant and equipment, net                             5,319,000      11,882,000       9,553,000
                                                           -------------    ------------     -----------
Other assets:
    Costs in excess of net book value of acquired
       subsidiaries, net                                              --         351,000              --
    Investment in and loans to subsidiaries                   41,943,000      72,618,000              --
    Other                                                      5,699,000       1,041,000              --
                                                           -------------    ------------     -----------
             Total other assets                               47,642,000      74,010,000              --
                                                           -------------    ------------     -----------
             Total assets                                  $  58,070,000     106,943,000      34,419,000
                                                           =============    ============     ===========

          Liabilities and Stockholders' Equity (Deficit)

Current liabilities:
    Accounts payable                                       $     921,000       5,328,000       6,551,000
    Current portion of long-term debt                             90,000         839,000              --
    Other                                                      3,413,000       2,351,000       6,499,000
                                                           -------------    ------------     -----------
             Total current liabilities                         4,424,000       8,518,000      13,050,000
                                                           -------------    ------------     -----------
Long-term liabilities:
    Long-term debt, net of current portion                    78,635,000       2,034,000              --
    Intercompany loan payable                                         --      71,723,000      36,957,000
    Other                                                        125,000       1,880,000       1,319,000
                                                           -------------    ------------     -----------
             Total long-term liabilities                      78,760,000      75,637,000      38,276,000
                                                           -------------    ------------     -----------
Stockholders' equity (deficit):
    Common stock                                                  39,000      56,139,000      33,709,000
    Additional paid-in capital                                86,917,000              --              --
    Accumulated other comprehensive loss                      (9,165,000)             --      (9,165,000)
    Accumulated deficit                                     (102,905,000)    (33,351,000)    (41,451,000)
                                                           -------------    ------------     -----------
             Total stockholders' equity (deficit)            (25,114,000)     22,788,000     (16,907,000)
                                                           -------------    ------------     -----------
             Total liabilities and stockholders' equity    $  58,070,000     106,943,000      34,419,000
                                                           =============    ============     ===========

<CAPTION>

                                                           Eliminations    Consolidated
                                                           ------------    -------------
<S>                                                        <C>             <C>
                Assets

Current assets:
    Cash and cash equivalents                                        --       4,095,000
    Accounts receivable, net                                   (161,000)     19,101,000
    Inventories                                                      --      22,994,000
    Other                                                    (3,894,000)        781,000
                                                           ------------    ------------
             Total current assets                            (4,055,000)     46,971,000
                                                           ------------    ------------
Property, plant and equipment, net                                   --      26,754,000
                                                           ------------    ------------
Other assets:
    Costs in excess of net book value of acquired
       subsidiaries, net                                             --         351,000
    Investment in and loans to subsidiaries                (114,561,000)             --
    Other                                                            --       6,740,000
                                                           ------------    ------------
             Total other assets                            (114,561,000)      7,091,000
                                                           ------------    ------------
             Total assets                                  (118,616,000)     80,816,000
                                                           ============    ============

          Liabilities and Stockholders' Equity (Deficit)

Current liabilities:
    Accounts payable                                           (161,000)     12,639,000
    Current portion of long-term debt                                --         929,000
    Other                                                    (3,894,000)      8,369,000
                                                           ------------    ------------
             Total current liabilities                       (4,055,000)     21,937,000
                                                           ------------    ------------
Long-term liabilities:
    Long-term debt, net of current portion                           --      80,669,000
    Intercompany loan payable                              (108,680,000)             --
    Other                                                            --       3,324,000
                                                           ------------    ------------
             Total long-term liabilities                   (108,680,000)     83,993,000
                                                           ------------    ------------
Stockholders' equity (deficit):
    Common stock                                            (89,848,000)         39,000
    Additional paid-in capital                                       --      86,917,000
    Accumulated other comprehensive loss                      9,165,000      (9,165,000)
    Accumulated deficit                                      74,802,000    (102,905,000)
                                                           ------------    ------------
             Total stockholders' equity (deficit)            (5,881,000)    (25,114,000)
                                                           ------------    ------------
             Total liabilities and stockholders' equity    (118,616,000)     80,816,000
                                                           ============    ============
</TABLE>

                                                                     (Continued)

                                       35

<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)

                                       36

<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)

                                       37

<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)

                                       38

<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)

                                       39

<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            --             --
</TABLE>

<TABLE>
<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)

                                       40

<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:

                                      2000         2001
                                  -----------   ----------
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
                                  ===========   ==========

(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.

                                       41

<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>

                                       42

<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.

                                       43

<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:  March 15, 2002

                                           PACIFIC AEROSPACE & ELECTRONICS, INC.


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

                                       44