Good afternoon, ladies and gentlemen, and welcome to AAR's Fiscal 2016 First Quarter Earnings Call.

We are joined today by David Storch, Chairman, President and Chief Executive Officer; John Fortson, Chief Financial Officer; Tim Romenesko, Vice Chairman and Chief Operating Officer of Expeditionary Services; John Holmes, Chief Operating Officer of Aviation Services; and Mike Sharp, Chief Accounting Officer and Controller. .

Before we begin, I'd like to remind you that comments made during the call may include forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, as noted on the news release and the Risk Factors section of the company's Form 10-K for the fiscal year ended May 31, 2015.

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, President and Chief Executive Officer, David Storch. .

Thank you, sir, and good afternoon to those attending today, and thank you for joining us to discuss the first quarter results. I'm traveling today, so I'm not in our corporate offices, but John, Tim, John Holmes and Mike Sharp are.

So I'll direct the questions, the questions that are fired, if you have any direct questions for any of the guys, feel -- please feel free to ask them directly. .

Generally speaking, our first quarter was in line with internal expectations. If I may, just commenting on the businesses, Aviation Services sales saw an increase of $4.2 million compared to the prior-year quarter. Our distribution program businesses were strong. They delivered solid results.

Distribution business grew its customer base and is actually achieving slightly above plan. Our program activity is strong as well. Unfortunately, our trading business did experience some softness and performed below our internal expectations, but we do expect to rebound in the second quarter.

And you may recall, the trading businesses are really the ad hoc parts supply businesses. Some of the engine shop activity that we normally support, or that we do support, was a little softer this summer than we had expected. .

We also began during the period, although revenue will start in Q2, we started to ramp for our C-130 program in Afghanistan. We have our first wave of people in the country now and those revenues -- in the past, I think we've indicated about a $30 million contract.

We're now expecting that contract to be roughly in the range of $50 million or $10 million a year. It's a 5-year contract, and we should start seeing revenue in Q2. .

In our MRO network, we experienced higher utilization. You recall summer months are usually a little tougher as the airlines like to keep their aircraft flying during the summer. So we were -- we did take on some work that in the past we hadn't taken on, which is doing completion work and mod work for customer aircraft entering the service.

And so we had a -- generally speaking, a pretty decent summer period. We completed the consolidations of our Hot Springs business into our Oklahoma City business. We did incur a $1.9 million onetime cost, most of which was absorbed during the quarter. And going forward, we expect annual savings of about $1.5 million from this consolidation.

Also, our Lake Charles business was pretty business -- busy during the summer and did contribute to our earnings, where in the past they had been a drag on our earnings. Now as we look ahead, our order book is filling nicely and we are experiencing and seeing a fairly robust pipeline for our MRO services. .

Moving over to our Expeditionary Service business, sales were $21.5 million below the prior year, mostly due to the mix of flying positions in Airlift and lower Mobility product volumes. While Airlift was down year-over-year, performance was up on a sequential basis.

And during the quarter, we commenced operations on 2 new contracts, including our United Nations contract in Africa. I might be able to report here that the customer is very pleased with the service that we've offered to date. .

As we move on, on that business, we are looking to expand the contracted fleet and we have, again, in this business, a pretty robust pipeline of activity. And as we've communicated before, we will be commencing our Falkland Islands' search and rescue contract as a contractor to the U.K.

MoD, and that contract will begin work in the fourth quarter of our fiscal year. It's a fairly meaningful contract for the company. Our first contract of this type outside the United States, or I should say with a customer outside of the United States other than the United Nations contract, and we're very encouraged by what we see. .

Now we will be incurring training costs and positioning costs in our Qs 2 and 3, but we will be seeing good revenue stream and healthy margins coming out starting in Q4. And you may recall, that's a 10-year contract. So feel good about where we stand there. Mobility continues to be impacted by low defense spending.

And then during the quarter, we did take some actions to rightsize our overhead. Bookings appear to be on a slightly positive trend now, but growth in that business does remain a challenge for the near term. .

So with that, pretty much on balance. I'm pleased with Q1 results, and as previously indicated, we see a strong ramp in the second half of our fiscal year. We do expect sequential growth in sales and earnings Q2 over Q1, but getting to levels that we feel good about by our Q3 and Q4 time periods.

We feel very good about our balance sheet and our unused capacity and our abilities to move swiftly.

I think we indicated during -- in the earnings call that our debt to total capitalization is in the 15% range, and it gives us a lot of flexibility to take advantage of any opportunities that emerge as a result of financial uncertainty in -- around the universe. So yes, I think we're entering Q2 in a good position.

Should see, as I indicated, better results Q2 over Q1. And then getting to pretty improved, more consistent results by Q3 and then into Q4.

So we communicated this, you may recall, back in the March time period, we've gone through some significant change at the company, and we feel really good about what we've done and we feel really good about where we're positioned for the future. .

So with that, what I'd like to do is turn the call over to John to fill you in on some of the -- more of the financials and then open it up to the Q&A. .

Thanks, David. Good afternoon, everyone. I trust that each of you had a chance to read our earnings release. I'll talk about our financial performance in a little more detail. Let me start by saying that our sales for the quarter of $377.8 million were 4.4% less than our prior-year sales.

As David mentioned, we grew Aviation Services by $4.2 million or 1.3% year-over-year. Our Expeditionary Services segment, however, declined by 25.7% year-over-year. As expected, however, the segment grew 11.5% on a sequential basis due to the new fleet positions that David discussed in Airlift. .

On the profitability side, our results were impacted by the softness in trading and by the contract mix at Airlift. Our gross profit margin was 14.4%, consisting of 15.8% margin in Aviation Services and 7.4% margin in Expeditionary Services. .

SG&A as a percentage of sales in the first quarter was 10.4%. This is higher than it has been in recent quarters due to increased legal expenses, some of which will recur in the second quarter. Partially offsetting these increases was the realization of our corporate savings from actions we took in fiscal year 2015.

Depreciation and amortization, including the amortization of stock-based compensation, was $14.7 million for the quarter. For the first quarter, our effective tax rate was 34.9%.

During the quarter, the company used $63.7 million in cash flow from operations due to investments in our supply chain business, a large tax payment and the timing of receipts in MRO and at Airlift. Capital expenditures for the quarter were $15 million. Net debt grew $51.5 million from last quarter to end at $150.8 million. .

During the quarter, we paid $2.6 million in dividends and repurchased approximately 300,000 shares for $7.1 million. We also bought back $14.4 million of our convertible notes that are due in March of 2016. We started fiscal '16 with 35.1 million shares in the diluted share count and we ended the quarter with 35.1 million shares. .

Finally, we have 22 aircraft on our contract today versus 19 on August 31, 2014. Note that we plan to add 2 leased aircraft to the fleet by the end of the calendar year to serve on the Falkland Islands' contract that David was referring to. .

Thanks for your attention, and I'll turn the call back over to David or we can go straight to Q&A. .

Thanks, John. So why don't we move on to the Q&A, please. .

[Operator Instructions] Our first question comes from the line of Robert Spingarn from Crédit Suisse. .

Hopefully, you can hear me. So that was a nice rebound there, a modest rebound, I should say, in Expeditionary. I was going to ask you, David and/or John, if you could talk about what we should expect in terms of flying positions as we go through the year. You mentioned the leased aircraft.

So we're at 22 now, which I think is one above where we were in July the last time we talked to you on one of these calls.

How do we -- how does the year play out here? And how should we think about getting from a 7.5% gross margin? Do we go back to the mid-to-high teens? How do we think about it? Can you frame that?.

John Fortson, would you please answer that, please?.

Sure. Robert, we are not giving guidance for the rest of the fiscal year. Obviously, we have a business plan out there, and we expect to see continued growth in our flying positions. You can extrapolate from the numbers that we've given you.

It's not too hard to envision that we could be in the sort of mid-to-high 20 aircraft positions if some things go according to plan. But obviously, there's execution risk in Afghanistan as well. So we feel good about where the fleet sits today.

I do think from a mix perspective, some of the contracts that we have today, we lost a couple of the very profitable S-92s and so that's impacting the mix unfavorably from a margin perspective. But I think that as the fleet gets back to a more normalized level in the back part of the year, you're going to see that -- those margins improve. .

Right, because when I look at the revenues on a year-on-year basis, they're almost flat, $316 million versus $318 million, but the profit is about 1/3 of what it was back then, 7% versus 18%. So what you're saying is we'll see some mix improve. We don't have to get -- triple the sales to get the same amount of profit. .

No. Look, I think that's right. I think you'll see some mix improve. I think we've got some operational opportunities to improve the efficiency of our fleet in different geographies. And then obviously as the other contracts come onboard that we expect to see that will help it as well. .

Okay. And then just the reluctance to go out with specific guidance, I don't know, David, maybe this is for you.

But what -- where does that hesitation come from?.

Well, I mean, we've been through a fairly significant transformation at the company. So my preference is let the dust settle. I think as we progress throughout the year, I think we'll be in a better position to offer up guidance.

So I think we indicated back in March that we were going to take a pause from guidance between now and through the second quarter of this fiscal year, and I'd like to stick with that at this point. So I think we'll have a lot more visibility come the second half of the year. We have to get all of our costs to flow through.

We've had a lot of onetime exceptional costs and we want to get our handle on those. And then we do have, as I indicated, a fairly -- a robust pipeline inside of the Airlift business, and we want to see how that fleshes out as well. .

And our next question comes from the line of Larry Solow from CJS Securities. .

Okay, great. On Aviation Services, David, I was wondering maybe if you could -- could you sort of parse out your thoughts for the remainder of the year. So I guess Q1 was a little weaker on your trading end of the business and I guess that sort of translates to some of the weakness, some of your -- some of the other aftermarket providers have seen.

Is that correct? And what sort of gives you confidence that it's a temporary thing? Is it just sort of the air miles and capacity still remain strong?.

Yes. I mean, I have a little bit of advantage over others in that I've seen this movie for the last 37 years. So my sense is that we've had a little bit of a lull. I've seen these before.

My -- in talking with some customers and talking with our people, I get a sense that things -- and I've already seen the month of September, that we are seeing some improvement.

Now I'm not excited yet, but I do believe that we will see strengthening throughout the balance of the year and that the first quarter was a little rough, but my sense is air miles haven't really diminished much and what you would say is the fleet age really hasn't changed a lot.

And I think similar to what you see with Southwest, we're taking 737-700s and putting them to work. I think my sense is that, that's more the norm than the -- than the not, than something out of the norm. So my view is that we'll see strengthening as the year progresses. .

Okay. And not to hold you to this, I know it wasn't a guidance number, but on the last call, you sort of threw out a sort of double-digit sales expectation. You don't have to necessarily confirm that, but it sounds like you're still pretty confident that whether it's 10, 8, 9 or whatever, you're pretty confident in the overall outlook. Is that... .

Yes. Yes, I am. .

Okay. And then on the MRO side, nice to see Lake Charles actually turn positive.

Is that just the tip of the iceberg? Do you -- how's the backlog look there? And what are your expectations as we go out?.

Well, I believe that Lake Charles itself, if I were to isolate Lake Charles, it still has certain risks associated with it because we're still trying to get a normalized pattern going there.

We came through the quarter, I think, in good shape and we have some optimism, but I'd like to hold back, reserve my comment on that till I see another quarter or 2 under our -- have another quarter or 2 under our belt. So in general though, if I can comment on MRO, in general, I feel very good about our prospects.

And I -- we're having good interaction with our customers, we're getting a sense that there's a fair amount of demand that's pent up and we expect good solid results through the balance of the fiscal year from our MRO activities. .

And on prior calls, I think if we go back to even several quarters back, landing gear had some slowness and it was -- you were discussing it sort of being a cyclical downturn.

Have we seen sort of the inflection point? Or do you still expect that to -- is that part of your positive outlook?.

Well, not as much as it is on the heavy maintenance side. However, we do see a better, let's say, Q2 over Q1 but still not satisfied with the level of inputs and still not achieving the same levels we've had in the past. So I'd like to reserve my comments there as well. .

Okay. And just on the SG&A line, I think you -- there was the -- what was the -- the severance for the consolidation in the MRO space was that, that $1.9 million.

Was that actually -- you didn't call -- pull that out as non-recurring, right?.

Yes, some of that occurred in SG&A and some of that occurred in direct expense. The biggest single item that would be unusual in the SG&A would be the legal costs that we've -- some of the legal costs that we've incurred. .

Right. Okay. And then just last, and I don't want you -- I know you've put out a comment yesterday in terms of some of the legal stuff going on in your Expeditionary Services. I realize you probably can't comment on that or where we stand with the State Department contract.

One thing that sort of caught me by surprise, and I don't know if you can care to comment on it at all, but on your website, I see you're sort of solicitating for a potential employment.

You still said that decision hasn't been made so that disclaimer is clear, but can I read anything into that other than you just -- or you're just being prepared in case you get that contract? Any thoughts?.

Yes. Yes, we're getting -- that's in preparation in the event that we are -- that we win that contract. That's correct. .

Our next question comes from the line of Kevin Ciabattoni. .

Just to follow-up on Rob's first question on Airlift, I know last quarter, you talked a lot about the start-up costs associated with some of these new contracts.

Just curious if you saw any of that flow through here in 1Q, and maybe what we can expect -- should we expect margins to maybe dip in 2Q with -- as some more of those start-up costs creep up?.

Tim Romenesko, why don't you take that question?.

Sure. Yes, so we are expecting to have start-up costs on the Falklands program in Q2 and Q3, and it will be $3 million to $4 million. It's people costs, it's training costs, it's positioning costs.

And so we think that, that will have an impact between Q2 and Q3; and then Q4, when the program starts, obviously those costs go away and then we flip around into profitability. So those are -- that's the biggest start-up costs that we're seeing in front of us for the balance of the fiscal year. .

Tim, is that $3 million to $4 million cumulatively or per quarter?.

Yes, yes -- no cumulative, spread over the 2 quarters. .

Okay. Any particular -- you touched a little bit on the weakness in trading that, I assume, impacted supply chain kind of the flat quarter year-over-year.

I mean, was there anything else in supply chain in the quarter that was -- that kind of came in below expectations? And then anything specific in that trading business that caused that?.

John Holmes, you want to answer that question?.

Sure, sure. Outside of trading, the rest of Aviation Services actually came in at or above expectations. Trading was the single area that was below, and there really was not 1 single product or category that was soft. We felt it in multiple ways across the business, both on the engine parts and the airframe parts side.

The only thing I would say is that in certain areas, we saw weak demand and we had supply. And in other areas, we saw strong demand but we were unable to get our hands on the material to fill that demand. So we had a couple of different dynamics going there. .

Okay. That's helpful. You mentioned in the press release and on the call -- I think, John, this is probably directed at you -- some investment, inventory investment for supply chain.

Was that related to contracts, ones that you've already announced or business that you're kind of going after that we haven't seen flow through yet?.

That's our contract wins that are already announced. So building off of programs that have already been won, and those investments are in line with the plan. .

Okay. And then last one from me and I'll jump back on queue.

Any color you can give on -- your thoughts around maybe additional stock repurchase activity going forward here, just kind of based on where the stock is relative to where we it was when we last talked?.

I'll take that one, and we will watch that closely. We have about $95 million left on our authorization and we will look at that closely. .

[Operator Instructions] Our next question comes from the line of J. B. Groh from D.A. Davidson. .

John, I just wanted to clarify on the SG&A.

You had some of that legal -- the legal is all on SG&A? And severance is split into the segments?.

Yes, that's, right. That's right. .

Okay.

So what's the appropriate level of SG&A kind of on a go-forward basis based on your -- you had a pretty nice decline here quarter-to-quarter?.

Well, we'd like to get it down. We've historically operated, call it in the sort of 9.5% range, and anything north of that, we're sort of not happy with. But I think we want to be clear, I mean, some of these legal expenses we expect to sort of continue for a while. .

Okay. So those will persist for... .

A couple of quarters, I would think. .

[Operator Instructions] Our next question is a follow-up question from the line of Robert Spingarn. .

Okay. So David or John, I'm back with just some cadence questions. David, you said earlier Q2 is going to be a little better sequentially than Q1, and then you're going to have more consistent results for Q3 and Q4, the kind of results that you would feel good about.

Can you give us a little better sense of what that actually means in terms of just relative to Q1?.

Well, I would expect that through the balance of the year, we will continue to see improving results and... .

That part, I got. So I'm looking at $0.23 in Q1. .

Right. .

I've got a 7% margin in Expeditionary. I think, John was saying that will go up, though it sounds like it may go down before it goes up. .

In the back part of the year, Robert, right. .

Okay. Okay. So let's just start there.

Does that mean that Expeditionary is a negative gross margin in Q2?.

Not to our expectations. .

Okay, because you can absorb a couple of million dollars or half of that cost you talked about and still be slightly positive?.

That's correct. We expect to be positive in Q2. .

Positive? And then similarly positive in Q3 within a real nice number in Q4? Is that how I think about Expeditionary profit?.

Yes. .

Okay. Okay. Fair enough.

And then on the Aviation side, given the fact that some businesses were better than expected, others were worse, is that profitability level -- is $50 million in gross profit per quarter kind of a steady run rate here? Is it going up?.

We expect to do better. .

Okay.

And just cadence-wise, how do we think about each of the other quarters? Do you expect to do better -- sort of similar jumps per quarter or is it back-ended?.

Well, I think you're going to see an improvement, a steady improvement in Q2, and then, hopefully, you'll see meaningful improvements in Q3 and Q4. And then what I was really referring to, Rob, is more from a historical perspective. I think we'll get into historical return levels by Q3. .

By Q -- that kind of a run rate, which would then mean -- and I don't want to get too far ahead of ourselves -- that next year, presuming things go the right way, you can actually get to a full year type historical level?.

Yes, correct. And -- yes, correct. So we're saying, just so everyone is clear, we're seeing strength in our businesses in the commercial markets. We see opportunities in the Airlift market. We have softness in the defense spending for our Mobility businesses. That would be, I would say, a general overview of our businesses.

And we would expect that the supply chain business will continue to improve, as will the MRO businesses and we see a little bit of choppiness still in the Airlift business. We feel better about that once we have the Falklands contract operating versus spending money to get ready for it to operate. .

Right. I don't know if I'm still connected here, but does that -- it sounds to me, David, like what you're saying is when you get all that together again, you're back to doing $0.50 a quarter and maybe better, but the next quarter or 2 are going to be -- won't be quite there.

There'll be somewhere between the $0.23 you just did and that target of $0.50, $0.60 a quarter?.

I think that's a good way to look at it. .

And our next question comes from the line of Larry Solow from CJS. .

David, just a quick follow-on, just on the Mobility business, obviously, continuing to remain soft. Do you think we're close to a bottom or -- I'm not -- obviously, it's hard to predict a rebound, especially... .

Yes. We've predicted close to bottom before and….

And we've been wrong. So have I. .

And we've been surprised ourselves. So what I would like to do is just wait and see how the government reacts to all the different skirmishes and activity around the world. Right now, they've been very passive, as you know, and that's impacted our business.

If, in fact, troop levels stay steady or strengthen and we actually put troops, move troops around then it should spell opportunity for our business. But we've been a little bit surprised at the softness, and don't know precisely if we're at the bottom. But maybe -- Tim Romenesko, maybe you can give a little more color on that, if you don't mind. .

I'm -- David's right. We predicted the bottom before and we've been wrong. We are seeing a little bit of year-end activity around a couple of product lines. But other product lines are pretty quiet, so I think David's characterization is right on. .

And the legal expenses, I mean, not giving an exact number, is there somewhere like $2 million, $3 million or something per quarter?.

Not that high. .

Not that high. Okay. Okay. .

[Operator Instructions] Our next question comes from the line of Kevin Ciabattoni. .

One quick follow-up, just wanted to touch base on the ExpressJet agreement with Airinmar that you guys announced recently. It seems like a pretty, pretty nice win. They've got a fairly sizable fleet.

Is that new work for you guys or something that you've been doing with them in the past?.

John Holmes?.

Yes, sure. That -- no, that is new work. That's a new contract. The scope of that is, I would characterize it as a modest start, but there's an opportunity to add on the rest of the Airinmar services with SkyWest ExpressJet. So no, that is a new win for that business. .

Thank you. And that concludes today's question-and-answer session. I would like to turn the call back over to Mr. Storch for any closing remarks. .

Well, thank you very much. Thank you for your attendance today and thanks for your very thoughtful questions. We remain very excited about our business. We feel really good about our position, feel really very positively about our balance sheet and the opportunity pool that we're looking at.

So look forward to our next call, and hope everyone has a great day. All the best. .

Ladies and gentlemen, thank you for attending today's conference. This does conclude today's program. You may now disconnect. Everyone, have a great day..