David Storch - Chairman, President and CEO Mike Sharp - CFO Tim Romenesko - VP and COO of Expeditionary Services.

Lee Jagoda - CJS Securities Kevin Ciabattoni - KeyBanc Capital Stan Mann - Mann Family Investments.

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

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

Before we begin, I would like to remind you that comments made during the call may include forward-looking statements as defined by Private Securities Litigation Reform Act of 1995, as noted in our news release and risk factor 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 turn the call over to AAR's Chairman, President and Chief Executive Officer, David Storch..

Thank you, sir, and good afternoon and thank you for joining us today to discuss our second quarter of fiscal 2016 results. Overall, as you can see, it was a strong quarter and top line growth and cash flow generation and performance was consistent with our expectation.

I plan to share some of our highlights on business performance and I'll turn it over to Mike Sharp who will provide more detail on the financials and then we will come back to the Q&A.

First off, Aviation Services saw a growth in sales of $33.7 million on a comparative to prior year basis which was up 10.3% and just reiterating that's organic growth, no acquisitions in the period.

Distribution programs delivered strong results again in both – supported both our commercial and government end markets as our innovative solutions and services are resonating with key customers.

During the period, our C-130 support program for the US Air Force in Afghanistan began generating revenue and we launched a repair management program for the Royal Saudi Air Force as a subcontractor to Northrop Grumman. We're experiencing improved operational performance on our largest airline consumable and expandable program.

Trading improved on a sequential basis, but was down year-over-year and across our one MRO network, we experienced double-digit growth driven largely by higher utilizations in our hangers.

We continue air work in Lake Charles which reported a record top line this quarter and Duluth celebrated the completion of its 200th aircraft for Air Canada marking a new milestone in what has been a great customer relationship. Landing gear repair was up 16% of the period on higher volumes.

And looking ahead to the second half the year, we expect continuous strength in supply chain as we ramp some of our distribution program contracts and continued strength in MRO based on robust order book and increasing bid activity.

Expeditionary Services on the other hand saw a sales decline of $13.2 million from the prior year, largely due to lower demand and delayed decisions for program awards by our government customers. Airlift was down year-over-year, but performance was up slightly on a sequential basis.

And during the quarter we were awarded extensions on our VERTREP program and we also started incurring costs associated with our MOD, British Ministry of Defense program support of the Falkland Search & Rescue contract. Mobility also was negatively impacted by lower demand.

However, our integrated technologies sub-business inside mobility did announce some contract wins during the period with US Air Force and US Army.

As we look ahead to the second half of the fiscal year for this segment, our customers, although they foresee needs for airlift services, solicitations continue to be delayed largely due to insufficient funding and political uncertainty.

And due market headwinds, we do expect continuous softness in the third quarter for this segment and then some improvement come Q4 as the revenue for the MOD Search & Rescue contract kicks in. We continue to be market leaders in airlift mobility. We remain confident in our ability to win new awards when decisions are made and new RFPs hit the market.

So with that, if I may, let me turn it over to Mike and he can provide a little bit more financial color..

Thanks David, I trust that each of you have had an opportunity to review our earnings announcement. I want to discuss our second-quarter performance in a bit more detail and start by saying that sales for the quarter were $423.8 million, which is up on a consolidated basis, 5.1% over the prior year.

As David mentioned, aviation services sales increased $33.7 million, up 10.3% year over year, while expeditionary services segment reported a 17% decline in sales. The gross profit margin in aviation services was 16.2% this quarter compared to 16.5% last year.

A slight decline in the margin year to year at aviation services was principally caused by mix within our supply chain activity reflecting increased program and distribution sales and less trading revenue.

In the expeditionary services segment, the gross profit margin declined to 2.6% of sales caused by the decline in revenues, mix of business within the segment and as David mentioned start-up costs associated with the Falkland Islands contract. SG&A expenses in the period were 10% of sales compared to 10.4% in our first quarter.

As many of you know, this ratio has historically run between 9% and 10% for the company. We feel good about our cost structure and the real opportunity for additional improvement in this ratio is by increasing sales.

Net interest expense was $1.5 million in the period compared to $6.5 million last year and reflects the significant decline in outstanding borrowings. Our effective tax rate for the period was 33.8% and includes a small favorable adjustment for our completed state tax audit. We expect our tax rate to approximate 35% in the back half of the year.

We had strong cash generation in the quarter generating a little under $48 million of cash from operations. Capital expenditures for the period were $15.7 million, inclusive of two payments on two AW189 rotary wing aircraft that was since sold and leased back. These are the two aircrafts we will be using on the British MOD contracts in the Falklands.

Depreciation and amortization, including amortization of stock-based compensation was $14.3 million. Net debt declined $43.3 million from August 31, to end debt $107.5 million. During the period we bought back 9.7 million of our convertible notes. The remaining amount of the convertible notes is 25.7 million and will be retired March 1, 2016.

The book expense interest rate on these converts is 7.4% and we expect additional annual interest savings of approximately $1.4 million once these notes are retired in March. During the period, we paid $2.6 million of dividends and repurchased 142,000 shares in the open market for $2.8 million.

As of November 30, there is a little over $91 million available under the Board authorized share repurchase plan. Now thanks for your attention and I will turn the call now back over David. .

Thanks Mike. So as you can see pretty good quarter, good double-digit organic growth in aviation services, good cash flow. Balance sheet is in wonderful position. We’re kind of looking for ways to invest the capitals wisely. We do have some deal flow but we are staying very similar discipline in our deployment of capital.

So with that let me open up to any questions you might have..

[Operator Instructions] First question is from Larry Solow of CJS Securities. Your line is open..

Hi, this is actually Lee Jagoda for Larry, good afternoon.

Can you quantify the sort of expenses from the Falkland contract in the quarter and what if any additional expenses you might expect prior to the contract generating revenue?.

I mean we are not necessarily disclosing that this moment, but it’s not insignificant. It’s a little bit – it will be higher in Q3 than it was in Q2, but then we will start, obviously as we start getting revenues in Q4, it turns from being a drag to being a contributor. .

Sure.

And then looking at Aviation Services, given that it sounds like the trading and parts business was actually a negative to the growth, what, in your opinion, is driving the strong growth? And how do you look at the sustainability of that going into the back half of the year?.

Well, I think we’ve made a series of – we have had series of contract wins. I believe our business model is appealing to a broad range of customers commercially, and our commercial markets and defense customers.

And yes, I think our team is doing a nice job, good leadership coming out of John Holmes’ office and his team surrounding him is executing and doing a good job..

Okay. And one more from me and I'll hop back in queue.

Are you guys seeing any of the benefits from lower oil prices and extending the useful lives of aircraft in the fleet?.

I don’t really – I won’t have an answer for that, that would be quantitative in nature. My sense is that fleets are – that the airlines are adding capacity and more capacity is good for our business. .

Fair enough. Thanks very much. I'll hop back in the queue..

Thank you. Next question is from Kevin Ciabattoni of KeyBanc Capital. Your line is open..

Hi, good afternoon, guys. Thanks for taking my questions. Nice quarter. You mentioned the parts trading business down year-over-year but up sequentially. I mean, are you better positioned now, you think, in terms of your inventory? I know, I think last quarter it sounded like maybe there was some mismatch there.

Maybe, David, if you could just give us an update..

I think our inventory is in good position. We were a little bit surprised Q1 in terms of the softness. I believe our inventory has probably ballooned a little bit Q1 and I think they are probably more in line with the results coming out of Q2.

So we have a great position in this market, not just here in the United States, but worldwide and we had nice improvement, Q2 over Q1, notwithstanding the fact that on a year-over-year basis, we were down. So great team in place, and again, I believe that that market – our performance will be fine. .

Okay. Can you give us an update on what – where you are in terms of airlift positions to finish the quarter, and maybe also kind of what the bid pipeline's looking like there currently? I know it sounds like there are some delays in terms of awards, but just in terms of what you're seeing on RFPs, et cetera..

Let me turn it over to Tim Romenesko..

Yeah, so we ended the quarter with 22 positions, but then on December 1, three positions – three contract positions were completed. Those we expect to be put out for rebid here in the next few months and we got a chance at least to get those back.

There are a few other larger RFPs that we think are going to be coming, we heard are going to be coming, but we haven’t seen them yet, and these are the RFPs that we have been talking for a few quarters here. So as David mentioned in this comments, they have been slow to hit the market and it’s impacted our results and our outlook. .

So, with those three positions rolling off ahead of the Falklands coming back – coming on in 4Q, I mean, is it likely that we'll see negative gross margins out of expeditionary in the third quarter?.

We’re looking – the third quarter we're expecting to be lighter than the second quarter due to the three positions coming out as well as the increase in cost that David referred to related to the startup of the Falklands program, so yes..

Okay. And last one, I’ll jump back in queue.

Any update you can give on where things stand with the DynCorp legal matter and then also related to that, I guess where the recompete stands for that program? We've also heard that they’re considering splitting that contract up into multiple silos, does that impact your revenue opportunity there on the recompete?.

Well, they already split a year ago from the traditional INL contract. So that's pretty well known -- that's generally well-known. In terms of our expectation for the current bid, let's say, we're not aware of any – there has been no indication of a desire to split that.

So we think we have a good competitive solution set and we maintain, we’ve submitted our proposal and we’re waiting to hear..

Have you got any update on timing there as to when they expect to award that?.

I think we’re led to believe somewhere in the January-February timeframe..

Okay.

And nothing on the legal matter that you can?.

No. I mean I think so far, all decisions have been -- are public in nature and have been favorable towards us..

Okay. Thanks guys..

Thank you. [Operator Instructions] Next question is from Stan Mann of Mann Family Investments. Your line is open..

Yes. Good afternoon. I have three questions.

One on cash utilization, David, you mentioned acquisitions, you mentioned buybacks, is there anything you can, any color that you can give us on your sense are acquisitions near, far, are they -- are you looking at accretive, a little color on cash utilization?.

The only confidence I have is accretive. So anything that happens will be accretive. In terms of near or far, it will be relatively out of our control. We are actively engaged on a few situations, but it's hard to say whether decisions are imminent or not. So we will continue to look at all the different possibilities.

Obviously, the balance sheet is in very strong position and with some of the uncertainty in the world, we view that as a pretty good position to be in..

Okay. And the buybacks, of course, you have $91 million, which could be a significant reduction in shares outstanding? There seem to be worse that are occurring or battles, including the Saudis and Yemen with Air Force and troops. And now I guess the Great Britain and US are sending operations teams to Helmand Province in Afghanistan.

Will any of those events have a near term effect on our business?.

I'm not sure. I can't say I have an answer to that. I think if pace picks up, so there is more action, then it will have a favorable impact on our business, but I can't comment because I just don't know if moving people into Helmand province or other things you referenced will have an impact on our -- meaningful impact on our business..

Okay.

The reason I asked about the Saudis is you said that you had a Saudi air repair contract that you jointly administer?.

Right. So yeah, I'm not aware of any direct impact. Our relationship with the UAE, they are also actively engaged in the Yemen market, should be favorable to, but I can't think of anything short term..

Are you seeing additional solicitations or interests?.

We’re seeing lots of interest and we are seeing solicitations. I don't believe the necessary related to those items, Stan, I think they’re related to the needs in a general sense..

Okay.

It’s positive though potentially?.

I don't think how it can get any more negative..

Okay. Thanks. Good job, gentlemen..

Thank you..

Thank you. I'm showing no further questions at this time..

Okay. Well, thank you, ladies and gentlemen for participating and thank you for your confidence in our company. Appreciate. Take care. Bye-bye..

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day..