Note 1 — Basis of Presentation

AAR CORP. and its subsidiaries are referred to herein collectively as “AAR,” “Company,” “we,” “us,” and “our,” unless the context indicates otherwise. The accompanying Condensed Consolidated Financial Statements include the accounts of AAR and its subsidiaries after elimination of intercompany accounts and transactions.

We have prepared these statements without audit, pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”). The Condensed Consolidated Balance Sheet as of May 31, 2018 has been derived from audited financial statements. To prepare the financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”), management has made a number of estimates and assumptions relating to the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Certain information and note disclosures, normally included in comprehensive financial statements prepared in accordance with GAAP, have been condensed or omitted pursuant to such rules and regulations of the SEC. These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in our latest annual report on Form 10-K.

In the opinion of management, the condensed consolidated financial statements reflect all adjustments (which consist only of normal recurring adjustments) necessary to present fairly the condensed consolidated financial position of AAR CORP. and its subsidiaries as of August 31, 2018, the Condensed Consolidated Statements of Income, Condensed Consolidated Statements of Comprehensive Income, and Condensed Consolidated Statements of Cash Flows for the three-month periods ended August 31, 2018 and 2017, and the Condensed Consolidated Statement of Changes in Equity for the three-month period ended August 31, 2018. The results of operations for such interim periods are not necessarily indicative of the results for the full year.

New Accounting Pronouncements Adopted

In March 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-07, Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. This ASU requires an employer to report the service cost component of net periodic pension benefit cost in the same line item as other compensation costs for those related employees. Other components of net pension cost, including interest, expected return on plan assets, and actuarial gains and losses are to be presented outside of operating income. We adopted this ASU on June 1, 2018 which resulted in $0.3 million of pension income included in Other expense, net in the Condensed Consolidated Statement of Income for the three-month period ended August 31, 2018. The Condensed Consolidated Statement of Income for the three-month period ended August 31, 2017 was not restated as the non-service cost components of pension expense were not material to fiscal 2018.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASC 606”), which provides guidance for revenue recognition. ASC 606 superseded the revenue recognition requirements in Accounting Standards Codification (“ASC”) 605, Revenue Recognition, and most industry-specific guidance.

We adopted ASC 606 on June 1, 2018 using the modified retrospective method. Under that approach, prior periods have not been restated and continue to be reported under the accounting standards in effect for those periods. A discussion of our revised accounting policy for revenue recognition is included in Note 3.

We elected to use the practical expedient allowing for the application of ASC 606 only to contracts that were not completed as of June 1, 2018. We recognized the cumulative effect of initially applying ASC 606 as a decrease of $20.4 million to the opening balance of retained earnings as of June 1, 2018. The impact of the adoption of ASC 606 on our Condensed Consolidated Balance Sheet was as follows:

	As of May 31, 2018		ASC 606 Adjustments			As of June 1, 2018
Accounts receivable, net	$	202.0	$	(31.4	)	$	170.6
Inventories	460.7		(17.3		)	443.4
Contract assets—current	—		49.6			49.6
Other current assets	26.2		(0.9		)	25.3
Other non-current assets	118.9		(19.0		)	99.9
Accrued liabilities	138.3		9.1			147.4
Deferred tax liabilities	15.7		(6.6		)	9.1
Other liabilities and deferred income	62.2		(1.1		)	61.1
Retained earnings	733.2		(20.4		)	712.8

The adoption of ASC 606 impacted us in three primary areas. First, we have certain contracts in which revenue is recognized using the percentage of completion method over the expected term of the contract. Under ASC 606, the contract term used for revenue recognition purposes was shortened to exclude any unexercised customer option years or incorporate customer rights to terminate the contract without significant penalty as we do not have any enforceable rights or obligations prior to the exercise of the underlying option. The impact of this change as of June 1, 2018 resulted in the elimination of certain deferred costs and the establishment of accrued liabilities reflecting our estimated obligations under the contracts. For this change, we recognized a decrease of $22.1 million to the opening balance of retained earnings as of June 1, 2018.

Second, we have contracts under which we perform repair services on customer-owned assets whereby the customer simultaneously receives the benefits of the repair. These contracts also transitioned to an over time revenue recognition model as of June 1, 2018 compared to our prior policy of recognizing revenue at the time of shipment. The impact of this change as of June 1, 2018 resulted in the elimination of certain inventory and accounts receivable amounts and the establishment of a contract asset reflecting the over time revenue recognition treatment. For this change, we recognized an increase of $1.3 million to the opening balance of retained earnings as of June 1, 2018.

Third, we have certain contracts under which we manufacture products with no alternative use as the customer owns the underlying intellectual property and we have an enforceable right to payment from the customer. As a result, we now recognize revenue for these contracts over time as opposed to at the time of shipment which was our policy prior to June 1, 2018. The impact of this change as of June 1, 2018 resulted in the elimination of certain inventory amounts and the establishment of a contract asset reflecting the over time revenue recognition treatment. For this change, we recognized an increase of $0.4 million to the opening balance of retained earnings as of June 1, 2018.

The impact of the ASC 606 adoption on our Condensed Consolidated Balance Sheet as of August 31, 2018 and our Condensed Consolidated Statement of Income for the three-month period ended August 31, 2018 was as follows:

	As Reported		ASC 606 Adjustments			Balances Excluding ASC 606
Accounts receivable, net	$	191.0	$	26.3		$	217.3
Contract assets	48.8		(48.8		)	—
Inventories	467.7		20.0			487.7
Other current assets	34.5		0.9			35.4
Other non-current assets	90.7		19.4			110.1
Accrued liabilities	110.8		(11.4		)	99.4
Deferred tax liabilities	11.0		6.6			17.6
Other liabilities and deferred income	73.5		4.6			78.1
Retained earnings	725.2		18.0			743.2

	As Reported		ASC 606 Adjustments			Balances Excluding ASC 606
Sales	$	466.3	$	(4.8	)	$	461.5
Cost of sales	395.1		(1.6		)	393.5
Gross profit	71.2		(3.2		)	68.0
Provision for income taxes	2.3		0.8			3.1
Income from continuing operations	18.9		(2.4		)	16.5

Excluding the ASC 606 adjustments from our reported results for the three-month period ended August 31, 2018, our Condensed Consolidated Statement of Cash Flows would include the changes of asset and liability accounts described above, with no impact on our net cash used in operating activities.

New Accounting Pronouncements Not Yet Adopted

In February 2016, the FASB issued ASU 2016-02, Leases. This ASU amends the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets, including those classified as operating leases under the current accounting guidance. In addition, this ASU will require new qualitative and quantitative disclosures about the Company’s leasing activities. This new standard will be effective for us beginning June 1, 2019 and is required to be adopted using a modified retrospective approach. The new standard provides us an option to recognize the cumulative effect adjustment on retained earnings as of June 1, 2019 or as of the beginning of the earliest period presented. We are in the preliminary phases of assessing the effect of this ASU on our portfolio of leases. While this assessment continues, we have not yet selected a transition date nor have we determined the effect of this ASU on our consolidated financial statements.

In February 2018, the FASB issued ASU 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU permits the reclassification of tax effects stranded in accumulated other comprehensive income to retained earnings as a result of the Tax Reform Act. This new standard will be effective for us beginning June 1, 2019 with early adoption permitted. We are currently evaluating the impact of this new standard on our consolidated financial statements.