David Storch - Chairman, CEO Tim Romenesko - President, COO John Fortson - VP, CFO, Treasurer

Larry Solow - CJS Securities Tyler Hojo - Sidoti & Company Kevin Ciabattoni - KeyBanc Capital Markets Stan Manny - Manny Family Investments

Good afternoon ladies and gentlemen and welcome to AAR's Fiscal 2015, Second Quarter Earnings Call. Before we begin, I'd like to remind you that the comments made during the call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. As noted in our news release and the Risk Factors section of the company's Form 10-K for the fiscal year ended May 31, 2014. In providing forward-looking statements, the company assumes no obligations to provide updates to reflect future circumstances or anticipated or unanticipated events. At this time, I'd like to turn the call over to AAR's Chairman and Chief Executive Officer, David Storch.

Well, thank you very much everybody. We start today with a sunny day in Chicago, but no longer. And I want to welcome everybody to our second quarter call. I'm sitting here with a room full of my friends and compatriots, Tim Romenesko and John Fortson are with me and available to answer calls as we get into the call section of this call. Let me begin by saying that on balance, we had a good quarter far from great, but nevertheless, under all the conditions in which we are operating, we think we had a good quarter. In Aviation Services we had a mixed bag. Within our Aviation Service segment, the supply chain sales were up 15% year-over-year driven largely by strength in our program and aftermarket parts supports business. Our recently opened Brussels Hub is performing well and allowing us to increase our market presence in Europe, Middle East and Africa. We see continued strong demand for our unique supply chain services from airlines and maintenance providers across the globe. Our Defense Logistics business is also seeing some positive impacts as a result of increasing flying hours on certain other programs that we support. So for the second half of the year, we expect continued double-digit hopefully as high as 20% year-over-year growth from our Aviation Services supply chain business. MRO, we experienced year-over-year weakness although sequential improvement and we are entering the second half with strong bookings. So during the period, MRO sales declined 11.5% though as I indicated there was a slight up tick from sequential basis and year-over-year decline is largely due to lower engineering service work, which I believe we discussed in the past. We are seeing more customer interest in work at our newest MRO facility in Lake Charles both narrow body and wide body. And we expect the balance of fiscal year; we do expect sales growth in the mid to high single digits for our MRO business. Airlift within our Aviation Service sector continues to transition. We in the second quarter sales are down considerably in the 40% range as we had 17 aircrafts under contract as supposed to 40 back in May of 2014. For the balance of the year, we expect continued year-over-year sales declines, however, we are working multiple proposals and are expected to hear and hopefully announce positively in the next 30 days or so. Technology products, we are seeing strength in our Telair cargo group. We had 20% increase in sales on a year-over-year basis driven by growth in commercial products as well as deliveries of the A400M cargo systems. We expect continued strong year-over-year sales growth at Telair cargo group throughout the second half of the year. And the growth rates we expect are should be equal to or greater than the 20% growth we posted in this quarter. We continue to see reduction in our mobility and machine parts group, 23% reduction in mobility products and additional reduction in our machine parts business as well. But, for the balance for the year, we expect declines at these units, but not at the rates we experienced in the second quarter of this year. So final thoughts, some of you may have seen Thomson Reuters article, it's not our intension to comment on that article which – I'd be – but at the same token, I have indicated in the past that we are looking at taking action or actioning underperforming units. In our Technology Product segment, we continued down that path, while at the same time, I believe we are performing the proper function by as we do always performing – growing evaluation of our business units towards the goal of streamlining and focusing our business and also improving our returns on capital. So with that, I will turn the call over to my team colleague, John Fortson to fill you in on more of the details.

Thanks David. I trust that each of you had a chance to read our earnings release and on this call, I will just review a few key points with regards to our financial performance. Our consolidated gross profit margin this quarter was 16% down from 16.8% in the prior year period, this performance translated into a 16.9% margin for Aviation Services and 13% for Technology Products. SG&A as a percentage of sales in the first quarter was 9.6% that's slightly higher than 9.5% in the prior year period. However, in the aggregate, our SG&A expenses declined $4 million over the prior year period reflecting continued cost control efforts across the company. Our operating margin for the quarter was 6.6%. During the second quarter, we generated $16 million in cash from operations and our capital expenditures were $8 million. We paid out $0.075 per shares in dividends this quarter. Net interest expense for the second quarter declined to $9.5 million from $10.2 million in the prior year. Our net interest expense numbers continued to decline as we focus on paying down debt. On a year-over-year basis, our net debt is lowered by approximately $40 million. And during this quarter, we retired $30 million of our 1.625% convertible note. Depreciation and amortization including amortization and stock-based compensation was $19.8 million. For the second quarter, our effective tax rate was 32.7%, per our guidance in July; we expected to remain at this rate throughout the balance of the year. We entered the quarter with 39.1 million shares and the diluted share count. We did repurchase 70,000 shares at an aggregate value of $1.7 million during the quarter. Thank you for your attention. And I will turn the call to the operator for Q&A.

[Operator Instructions] The first question comes from Larry Solow [CJS Securities].

Hi, good afternoon. I was wondering if you can comment, David, on the dramatic drop in oil prices. Obviously, helps your commercial customers. Just in terms of the dynamic with some of the newer aircraft that have been coming online, because there's more economic incentive, but now with the oil coming down so much, maybe some of these fuel-efficient – the lack of fuel efficiency in the older aircraft, could they maybe stick around for a little bit longer? And would that directly help your business?

First of all, I think it's too early to tell. So the oil prices have dropped precipitously here in the last 90 days or so. So I'm not so certain that we have a trend yet. Clearly, our customers are benefiting from this low oil price rate. But I'm not certain at this point that's caused them to adjust their long-term fleet planning. Now, that said, our business as you can see – our business supporting the world's fleet is growing quite steadily and at very attractive rates, keeping in mind that all these growth rates are organic. So I believe, we are in a good position expanding our business I think nicely. A suite of products that we offer in supply chain arena in particular are very appealing. And I believe the spread we have now in terms of the capability in North America for airfare maintenance is also quite strong. So yes, I think that the economic environment is more friendly today than it's been in a while for the airlines. And as that continues whether they take on new aircrafts during that I believe we are well positioned.

Okay. And then you talked about some of the ramping of the aviation supply, some of those contracts. Can you comment how – I guess the two contracts at Eaton and the one at Unison are those still progressing in a positive direction?

Yes. Unison has been placed for a period of time and it's I think fairly steady.

Okay.

And the Eaton programs are in their launch phase and still in a build up phase. We are probably more of a net investor at this point in time than a net beneficiary. But, I would anticipate that as the other distributors work through their inventories, they will be in a good position to start seeing ramp in sales.

Okay. Then just lastly, you gave some nice itemized guidance over the back half of the year. Putting it all together, and I know sometimes you put annual guidance and don't necessarily look to change it out if you don't have to. But fair to say your full-year outlook is sort of within – where it's similar to what it was last quarter?

Yes. I think as we sit here today, we don't see anything different from what we saw at that point when we adjusted earlier in the year.

Okay, great. I appreciate it. Thanks.

Yes. Thank you.

The next question comes from Tyler Hojo [Sidoti & Company].

Good evening. Just – I totally understand you don't want to comment on the Reuters report. But, David, you did tell us that you would be willing to kind of update us on kind of some potential divestitures, I think, towards the end of the year. And I guess what I'm wondering is, it seems like cargo-loading systems and kind of the Telair acquisition just in general has been one of the better performing assets that you bought. I mean is there any reason to think that that's not kind of a core, in terms of what AIR does going forward?

Well, I think everything that we have in our portfolio today is core. So we are reviewing all our businesses this core. I think we are looking at how that we go ahead and maximize our investments. And so I think we are performing normal functions in that regard. And we will continue to do so. So I don't see any change in that regard.

Okay. That's fair. And then just in regards to aero structures and the initiatives there, I know kind of the strategy was to kind of try and improve the operational efficiency of those assets and then kind of try and determine what to do with that business. How have those businesses been performing? Are we back into the profit range now or still kind of where we were?

Yes. I don't believe we have seen much change in those businesses. So it's a little bit frustrating from our side. But as I indicated by the end of the year we should be in a position to talk more specifically.

Okay. Got it. And then just as it relates to your prior guidance, I think you are looking for your Airlift business to grow to 23 positions in the third quarter, is that still the expectation?

Yes.

Okay. Got it. And how feasibility do you have into that?

I think 100%.

Okay. Well, that makes it easy.

Yes.

All right, good. And then just one follow-up on the last questioners like of questioning just in regards to oil. What are you seeing – I mean with the drop in oil line, I'm assuming kind of your ability to kind of benefit from the surplus parts market becomes a little bit more challenging. But just what's your view on that? And then also I guess as it relates to your leasing portfolio, what do you think kind of the implications are for asset values there and does that potentially get you thinking that maybe you look to sell a few more of those assets in the back half of the year?

Well, first of all, I view the reduction in oil prices right now as positive. I would be hopeful that the price level will settle – if it settles in the range where we are today, I believe that's very positive for our industry and for ourselves. It's a little bit difficult knowing – it's a little bit difficult to pinpoint where oil prices may fall. But, nevertheless, I believe that the state of the airline industry when oil prices are in the 100 range were very positive. And I think with the price of the barrel being in the 55 to 60 range, it's even that much more positive. So I look at the industry. I look at the U.S. commercial airline industry as probably being the healthy as it's been since I have been in the industry. And it's helping us think about – think through our strategy as we look at the – how well they are doing and what their prospects look like. So I hope I'm answering your question. In terms of values on inventory, we are getting – we are able to make good investments. We have made some solid investments this quarter, while we still generate cash from our ops and free cash. So I believe that we have our tentacles out in the worldwide market. And I think we are in a good position to benefit as fleets grow and as fleets change. So yes, I think oil is just – the price of oil I think is contributing to what was already a fairly conducive environment for the things that we do.

Okay. Thanks a lot for that. Appreciate it.

The next question comes from Kevin Ciabattoni [KeyBanc Capital Markets].

Hi. Good afternoon guys.

Hi, Kevin.

Just real quick on airlift, I know – if my numbers are right, you finished last quarter at 19 positions, and it was – if I heard correctly down to 17 at the end of Q2 here. Just wondering if that was an expected drop, I know you said you still expect to get to the 23. I was just curious if that was baked in, because I was under the impression it was going to stay fairly flat?

Hi, Kevin. It's John Fortson. So we did have two aircrafts that were descoped that were not anticipated. So we technically finished the quarter at 17. But, we have actually picked up two aircrafts since quarter end. So we are back to 19.

Okay. I mean –

It's in different geographies. Sorry…

For those in Afghanistan?

No. It's in a different geography.

Okay.

But, yes, I mean we are tracking these obviously very, very carefully. The two that came out were not expected. But, we have actually had two incremental wins. So…

Okay. Okay. That's helpful. Any update on the aircraft held for sale, I think it was 15 at the end of last quarter. I was just wondering if you guys have made any progress there?

Yes. So we are sitting at 16 right now. We have had some progress. We haven't actually sold the aircraft. But, if we think we are getting closer on a couple and we feel like we will get some out of the door by in this quarter.

Okay, perfect. I know it's not a huge piece of the business, but engineering services, I was wondering if you can give us some color on how you think that shakes out in the back half of the year. I mean I guess its one part of the business we didn't really talk about the impact of oil prices here. But, I would imagine carrier profitability improves maybe cabin the refurb environment picks up a little bit and you guys can see some pick up there?

Yes. This is Tim, Kevin. We are working off a few contracts that we have now. But we are taking steps to broaden our customer base in engineering services. We have a couple of programs going on in Asia and a few programs in North America. But, as you know they are very lumpy. And the programs that we have today are smaller than the ones that we are working on a year ago. So we are investing in some resources now to be – have more exposure to some of the major reconfigurations – interior reconfiguration programs that are going on. We are seeing some opportunity out of our Lake Charles facility where we can do the touch labor. So hopefully by combining our touch labor capability as well as our engineering services capability bolts in North America and in Asia. We are hoping that we are going to able to cash more business there. But, for the balance of the fiscal year, what we see now is roughly inline with what we had in the first half of the fiscal year.

Okay. Thanks Tim. And then last one for me and I will jump back in queue. Any way you guys can quantify the 47-8, how that rate cut there next year, it sounds like would impact your business?

Well, it definitely has impact on the – at the cargo system and spares level. But, we do have deliveries in the second half of the fiscal year more so than in the first half of the fiscal year. But, the decline in production will over time obviously have an impact. And then also on some spares. One of the variables though is the split, the mix between passenger and freighter.

Right, right.

That it kind of reminds to be seen.

Okay. Thanks.

[Operator Instructions] The next question comes from Stan Manny [Manny Family Investments].

Hi, gentlemen. I have a couple of questions. One, David, on cash flow utilization, can we expect the emphasis on debt pay down or stock buyback?

Both at the right time, right? In this quarter, we reduced some debt and we bought in some shares. So I think we will continue to look at the best utilization for our cash Stan.

Okay. And then I have a question that you probably won't answer, but, the equity price is active at normally great in this environment and is there any comments or anything you would be able to say about that?

I believe that the shares are undervalued and represent a wonderful investment opportunity.

Okay. That's the question. Okay. Thank you for good job.

Okay. Thank you.

And I'm showing no further questions.

Okay. With that, I would like to thank you for your participation today. And I like to wish everybody a very happy and healthy holiday season. All the best.

Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.