David P. Storch - Chairman, Chief Executive Officer and Chairman of Executive Committee John C. Fortson - Chief Financial Officer, Vice President and Treasurer Michael J. Sharp - Chief Accounting Officer, Vice President and Controller.

Lawrence Solow - CJS Securities, Inc. Julie Yates - Crédit Suisse AG, Research Division Tyler Hojo - Sidoti & Company, LLC Jonathan P. Braatz - Kansas City Capital Associates J. B. Groh - D.A. Davidson & Co., Research Division.

Good afternoon, ladies and gentlemen, and welcome to AAR's Fiscal 2014 First Quarter Earnings Call.

Before we begin, I'd like to remind you that 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, 2013.

In providing forward-looking statements, the company assumes no obligation 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..

Thank you, sir, and good afternoon. Thank you for joining us today as we discuss our first quarter fiscal 2014 performance. I'm joined at our corporate headquarters with Tim Romenesko, our Chief Operating Officer; and John Fortson, our Chief Financial Officer; and Mike Sharp, our Chief Accounting Officer and Controller.

So here are some of the highlights from the quarter. Sales were $515 million, down 7% from $551 million the first quarter of 2013. As expected, sales in our Technology Products segment were down mostly due to lower levels of activity in our Mobility Systems business. This is partially offset by good performance at the commercial Cargo business.

In the Aviation Services segment, sales were down slightly from the prior year as we had lower sales in our supply chain business, which we expect to recover during our second and subsequent quarters.

We continue to see good results in our airframe maintenance operations where we are ramping up our Duluth facility and added a third line to meet demand. Further, we have a strong quarter at our Airlift business where we continue to maintain high readiness levels.

We're pleased to report that despite lower sales, our operating margin in the quarter was 7.4%, an improvement over the 7% operating margin reported in the first quarter last year. This improvement was the result of our continued focus on cost management and higher operational efficiency across several of our businesses.

Net earnings for the quarter was $0.45, equal to last year's diluted earnings per share. In this quarter, it's also important to point out that we continue our focus on cash generation, generating $27.5 million in cash from operations and $20.3 million in free cash flow, which is in excess of our net income.

We reduced our net debt by $22 million from May 31, which brings us down $109 million from August 31 last year, and paid dividends of $0.075 per share during the quarter. In the Aviation Services segment, sales were down slightly from last year.

Our MRO business continued to perform at high levels of capacity utilization, demand for maintenance services from our customers remains strong, and as previously mentioned, in late August, we added a third line in Duluth.

In addition, late in the first quarter, we announced the opening of our sixth North American aircraft MRO facility in Lake Charles, Louisiana. We received a limited authorization from the FAA on August 30 to begin operations at this site, and we are in the FAA's queue to receive full authorization as soon as possible.

The facility significantly expands our capacity as it will enable us to handle up to 7 wide- or 10 narrow-body aircraft at a time. And as we sit here today, we have 4 wide-body aircraft in the facility receiving maintenance.

During Q1, our Commercial Supply Chain Management business experienced seasonal softness, which we expect to recover throughout the balance of the year, mostly on deferrals and to satisfy supply-demands that are still there but basically will occur in Q2 and beyond.

Also subsequent to quarter end, we delivered the first of 2 customized 737 aircraft to the U.S. Marshal Service, and we expect to deliver the second aircraft in a few weeks. Our Airlift business produced strong results in the quarter and continues to maintain high operational readiness levels.

In early September, we received preliminary notice of intent from our customer to exercise its option of approximately $100 million of rotary wing contract revenue. As previously discussed, our Airlift business also has $110 million contract covering 12 rotary-wing aircraft expiring on November 30.

We believe there are a number of different outcomes for these aircrafts, including extensions on the expiring contracts as well as fulfilling customer requirements on other contracts. I'd like now to turn to our Technology Products segment. As anticipated, sales were down in this segment due to the year-over-year decline in our Mobility business.

We expect sales of our Mobility Products business to remain steady going forward and to be neutral to prior year's results for the balance of the fiscal year. Despite the sales decline, the business continues to be a market leader and a profitable contributor to the company's results.

In addition, our Commercial Cargo business continues to perform well year-over-year. In closing, we are encouraged with our earnings and operating margin performance in the quarter as the company continued to generate strong cash flow.

Sitting here today, we see many high-potential opportunities to grow the core business, both internally and externally. Thank you for your attention and support, and I will now turn the call over to John Fortson..

Thanks, David. I'll provide a bit more color around the financial performance of the company during the first quarter, including comments around interest, cash flow, capital expenditures and capital structure. Mike Sharp and I both will be available after the call to answer any questions that you may have.

Revenues in the first quarter were $515 million versus the prior-year level of $551 million. Aviation Services revenue at $394 million was essentially flat to prior year. As David mentioned, our airframe maintenance facilities and Airlift operations continue to perform well and were offset by lower revenues in our Supply Chain business.

Technology Products revenue declined 21% quarter-over-quarter to $121 million, driven by the expected decline in demand from mobility products, which saw a $35 million sales decline from last year first quarter.

Again, we expect sales of our mobility products business to remain steady going forward and to be neutral to prior-year results for the balance of the fiscal year. Our Commercial Cargo Systems performed well in the quarter. Consolidated gross profit margin in the first quarter was 16.5% compared to 16.4% margin in the prior-year first quarter.

As mentioned in our release, margins in Aviation Services segments improved to 16.6%, primarily driven by efficiency improvement in our MRO operations. On the Technology Products side, the decline in margin to 15.9% in this quarter from 19% in the first quarter of last year was primarily driven by the volume decline of mobility products.

Moving on, we did a really good job with cost management this quarter, bringing SG&A as a percentage of sales to 9.3% from 9.7% in the prior year quarter. We are attacking costs across the company and are pleased with the progress that we have made. Operating profit at 7.4% for the quarter was 40 basis points better than prior-year quarter.

As we've said before, improving our operating profitability is a focus across the company, and we're pleased to see this margin improvement, particularly with the revenue decline versus the prior year. We remain very focused on cash generation. During the first quarter, we generated $27.5 million of cash from operations.

We had $7.2 million in capital expenditures and $20.3 million of free cash flow. Net interest expense for the first quarter was $10.7 million, an increase over $10.2 million from the prior year primarily due to our upsized senior notes offering.

As mentioned by David, in this quarter, we reduced our net debt by $22 million sequentially and a $109 million over the 12-month period. Depreciation and amortization, including amortization of stock-based compensation, was $21 million during the first quarter.

Our first quarter diluted earnings per share is based on 39 million shares in our diluted share count, which is down 2.7 million shares from last year's level. Thank you for your attention and operator, we're now ready to take questions..

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

Just on the aviation supply, I realize the -- firstly, you had a pretty tough comp last year. I think growth was 13% organic. And I know quarters are -- it's a seasonally slower quarter and you don't guide to the quarter.

But did the little bit of the flatness catch you a little bit on surprise, it's all, I guess, in the supply chain? And is that all basically just time, really just a timing issue and....

Yes, our view is, first of all, yes, to some degree, we were expecting a stronger quarter. We had a few customers who deferred heavy-engine business, for instance and therefore, pushed off some of the activity into Q2. But we are expecting to recover the shortfall from Q1 into Qs 2, 3 and 4.

We also mentioned in our press release, we didn't mention in the conference call script, but we -- and that's just something we missed, but we are reaffirming full year guidance on sales and earnings..

Right.

And so I mean, you really haven't -- even in the mix between the 2 segments, hasn't really changed much? Or you still see sort of a basic -- sounds like it's all timing related?.

Yes, I think there's timing -- I think, Larry, if you look back 2 years ago this quarter, we had sales of about $490 million. So I think last year, we had -- we did have a strong quarter. We had a couple of individual situations that caused that to be. But so we did expect higher sales this summer from our supply chain.

But it's not -- we do expect that what we did -- what did get pushed off based on what our customers are telling us, we do expect to recover that business in the out quarters..

Okay. And I realized it's -- there's some slowness in this time anyhow.

Have you seen -- are you seeing orders or activities start to pick up as you get into a little bit seasonally stronger time in the fall?.

Yes, I mean, I think that we're -- we feel pretty good about how the quarter is starting. And as we've mentioned also, we will be delivering 2 aircraft this quarter. So we are expecting a fairly solid quarter..

And could you just talk a little bit about Louisiana in terms of scope? Is it sort of -- it sounds like it's similar in size to Indy, I guess, with -- you have more wide-body capabilities.

But that and then the second part of the question is sort of how do you expect to ramp sort of over the next couple of years?.

It's very different than any other facility that we have. So you're dealing with the -- each hangar is capable of handling wide-body aircraft. And the -- we view the capacity increase as approximately 7 wide-body and 10 narrow-body aircraft. We have received provisional authorization from the FAA to do work on the aircraft.

They're currently in the hangar, and we're in queue to get the full FAA license. So we're very early in that in our involvement, and it's a little bit hard to predict precisely what the ramp might be. But I would imagine that by a year from now, we'll have a much steadier -- first of all, have much more visibility.

And I think we'll have a steady, steady contributing business to our profitability. So we only received the provisional certification on August 30. So we're not even a month into the -- into having the operation. We have over 100 mechanics, and we are doing work on 4 customer aircraft.

And we are today looking to hire more mechanics and hopefully, we have a fully operational business by the end of the calendar year..

Okay. And then just the last question on the SG&A. You did a great job at bringing down costs, actually especially considering you're in a down sales environment, you're seeing improved leverage. Is some of that somewhat discretionary and timing related as well? Or is that....

Some are structural in nature and some -- keep in mind, last year, we were operating more facilities. We closed a couple of facilities last year. So some are structural in nature and -- but the preponderance of savings is around a sharp focus around spend.

So we're watching travel, we're watching freight, we're watching office supplies, shop supplies, and we're looking at the critical materials that go into some of our manufacturing businesses. So I think it's pretty much across the board, and we're -- I believe the effort is gaining momentum..

And our next question comes from Julie Yates from Crédit Suisse..

David, it looks like if you maintain this level of profitability, you'd be well ahead of the guidance that you're reaffirming today.

So can you help us just kind of understand, is this conservatism? Or are there other puts and takes later on in the year that I'm not factoring in?.

Well, I think we always -- we prefer to be under committed and over delivered. And I think it's our preferred approach. So yes, I mean, I think we feel that we're giving the appropriate guidance based on what we know, and we hope that we perform well against that guidance and exceed it where we can..

Okay.

And then was the Technology Products business, was it a little bit weaker than you had anticipated? Because I think last quarter, you said that you had expected that it had leveled out?.

No, no, no. We had indicated that we had at least 1 or 2 more quarters. And we anticipate that we -- that we pretty well level out at the end of this -- at the period we just ended. So we don't anticipate much more in the way of decline, very minor decline in Q2, which would be better than what we had previously communicated..

Okay.

And then just with all the news on -- out of the Air Force on KC-10 and the risk around that fleet being scrapped with -- in sequestration, can you help us think about -- I know the flight hour contract is at 0% margin, but can you help us just think about the risk for you guys there?.

I think if the Air Force goes the route of taking the KC-10 fleet down, they will do that as they take on new KC-46s I believe the number is. And so at least that's the way it's been explained to us by Northrop Grumman. Of course, those deliveries don't start out, I think, into what, '15 or '16, and there's a few a year.

And by the time these aircraft are out of service, our contract will have expired..

And our next question comes from Tyler Hojo from Sidoti & Company..

Just firstly, I was just wondering, perhaps, if you could quantify what the impact was in the quarter just from some of the deferred heavy-engine visits that you were referring to. Would commercial sales volumes, perhaps, been flat year-on-year if not for that? Just trying to put some context around that..

Yes, we're just trying to answer your question. Again we'll have to do the math to figure it out. But I'd say that, that if we would have had the sales that we were expecting, we would have at least had flat commercial sales. But I think maybe....

It would've been actually....

No, actually commercial sales, we just checked, commercial sales would've been stronger had the -- had what you mentioned happened..

Really? Okay. So talking about a pretty significant amount of work..

Well, keep in mind, the decline was relatively modest. So the decline is less than -- right around 1%, a little bit over 1%. So the sales that got deferred, had those sales happened, had we hit those targets, then we would've exceeded -- we would've had commercial sales growth, yes..

Okay. Understood. Thanks for the clarification. And then just in regards to the guidance range, I'm just curious what you all are anticipating in terms of future contribution from joint venture income? I think it was about $1 million in the quarter..

Tyler, this is Mike. That amount going forward is going to be reasonably modest. It's not going to be any more -- it should not -- we don't expect it to be any more than that amount in Q2, 3 and 4. So relatively modest number..

Okay.

And then just in context with that, maybe you could provide us an update with kind of where we stand with the owned and co-owned aircraft portfolio?.

There's no difference in our aircraft portfolio from year end. We have, I think, 4 aircraft owned in joint venture and then 2 aircraft in our wholly-owned portfolio..

Okay. Great. Just a couple of other ones here. You mentioned in regards to the Airlift contract that is still outstanding, I think it's $110 million, that that's coming up, I think, in November.

When would you expect to come to an agreement with your customer? Would it be sometime soon? Or would it, perhaps, stretch all the way to kind of the expiration of the contract that you currently have?.

I think we'll have some knowledge next week. We're expecting some knowledge next week. But there's a lot of shuffling, if you will, in terms of different possibilities and outcomes.

So we're in touch with the 4-star levels, and I think there's a little bit of -- I think they're trying to move things around and aren't really ready right at this moment to commit. But we anticipate some commitments as early as next week..

Okay. That's great. And David, in the past, you've discussed kind of the desire, I guess, to ultimately move some of your Airlift assets outside of Afghanistan.

Could you maybe talk about the pipeline there? Or are things kind of robust enough where you don't really need to worry about that anymore?.

Well, I think we still like to have a better balance to our fleet. So we still do worry about it and think about it, and we are offering assets into other markets. So yes, we continue to work that pretty actively.

And I would say that the deal pipeline in both regards, in the currency other as well as some -- other markets, is fairly brisk at this moment. But there is a fair amount of uncertainty coming from the customer in terms of what their actual requirements might be..

Okay.

So how would it work for you guys? Would you wait until you hear what the requirement is before you look to place additional aircraft outside of Afghanistan? Or would you be willing to essentially buy additional Airlift capability to fulfill additional contract?.

We may not buy. We may lease, or we may figure out another way to get -- to use that customer equipment, et cetera. So we're looking at a few different possibilities..

Okay. Great. And just lastly for me, I was wondering if you could provide us some guidance just in regards to CapEx and free cash flow for the year..

Tyler, I mean, I think you should think about our CapEx -- so we had a little over $7 million this quarter, sort of in that $30 million to $40 million range for the year, notwithstanding anything unusual.

I'm sorry, what was the second part of the question?.

Just free cash flow..

On the free cash flow front, I mean, what we've talked about fairly consistently over the last 12 months is identifying as our target free cash flow equal to our net income, and we've delivered on that. We've exceeded that in the last several quarters. So I think the way to think about that is equal to our net income..

[Operator Instructions] Our next question comes from Jon Braatz from Kansas City Capital..

Going back to Louisiana, given the lease payments and so on and the amount of volume you're running through that facility, is that a little bit of a drain on your profitability early on here?.

Very minor. But yes, I mean, it's more of a drain at this moment than a contributor..

Okay, but not really significant..

No, not really significant..

Okay. And then secondly, let's move forward, let's say 9 months, and you've done a good job of generating free cash and paying down debt.

And let's say you get to a point where you paid off another $75 million or something like that, would your focus return continue to be on free cash and debt repayment? Or would you be more inclined to shift a little bit and think about acquisitions and purchases? Or would you just continue to focus on debt repayment?.

So Jon, I think that there's kind of -- part of our thinking today is kind of looking a little bit more externally towards investments in deals. We're also looking at investing in program activity to support some of our supply chain initiatives. So I think the free cash flow picture could change as a result of 1 or 2 of these events occurring.

But in the meantime, we continue to drive the existing businesses to generate as much cash flow from operations as they can. And that energy will continue, and hopefully we'll be able to find good places to invest some of this capital we've been generating..

Do you think that could be more of a....

We're focused on EBITDA, the total to net debt. And I think we're making a nice dent in that and get that ratio right, and then we'll be kind of more apt to get more aggressive externally..

Do you think that could be -- would that be more of a fiscal '15 possibility, or still something happening this fiscal year?.

I think it might -- yes, it's possible you'll see some stuff happening in '14..

Our next question comes from J.B. Groh from D.A. Davidson..

I apologize if you've covered this, but could you give us the utilization rate in MRO in the quarter?.

In terms of hangar capacity?.

Yes, yes. How many slots are full, that kind of a thing..

Just kind of in general, it was a reasonably strong quarter for the MRO. During the summer, the inputs are always a little bit lighter, but they perform very well. We -- as we go into the balance of the fiscal year, the story gets a little bit tighter. But I'd say the first quarter was normal. We had some capacity.

But we're able to flex the workforce, things like that, to adjust for it. So....

Right. So there's the normal seasonality, but maybe if you're not willing to put out a number, I understand. But could you maybe talk about how it trended versus last quarter -- or I mean, last year rather..

Yes, no, it's positive in terms of the number of hours produced across the facilities..

And then when you look into, say, Q2 where on a seasonal basis you'd be busier, how do the kind of advanced bookings look relative to what you did last year?.

They look strong..

So up?.

Yes..

And our next question comes from Stan Mann from Mann Family Investments. We do have a follow-up question from Julie Yates from Crédit Suisse..

Can you guys disclose what the growth was in commercial and defense? Just the organic growth by end market?.

Julie, the sales -- there was a sales decline in defense right around 7%, and the sales decline in commercial was right around 6%..

Okay.

And do you have those figures for the full year '13 as well?.

I mean, not at my fingertips..

Yes, commercial, I believe, was up 19% -- 16% -- 14%. Commercial was up 14%, and defense was down 10%..

And we have a follow-up question from Larry Solow from CJS Securities..

Could you just update us on the Precision Manufacturing business? I know it's had a couple hiccups over the last few quarters. I think one last quarter.

Any update on that?.

So we continue to work through and address our issues there. And we feel like going into the second quarter, our performance will be significantly better than the first quarter and the last -- actually the last few quarters.

So I think we're making progress on it, Larry, and I think, like I said, I think this quarter, we should start to see some meaningful results from our efforts..

Okay. Just on Louisiana, I mean, I don't know how you can answer this, but it seems like it'll be a pretty modest negative impact early on. And maybe for the full year, not a huge impact positively.

But is it -- so is it fair to say sort of a pre-breakeven, maybe slight positive for the year?.

I'd be disappointed if it's not positive..

[Operator Instructions] And I'm showing no one in the queue at this time. I'd like to hand the conference back over for any closing remarks..

Well, thank you for your participation and look forward to our next call in 90 days. Thank you..

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program for today. You may all this disconnect, and have a wonderful day..