David Storch - Chairman & CEO John Holmes - President, COO & Director Michael Milligan - CFO & VP.

Kenneth Herbert - Canaccord Genuity Limited Lawrence Solow - CJS Securities Benjamin Klieve - NOBLE Capital Markets Joshua Sullivan - Seaport Global Securities.

Good afternoon, ladies and gentlemen, and welcome to the AAR's Fiscal Year 2018 Second Quarter Earnings Call. We are joined today by David Storch, Chairman and Chief Executive Officer; John Holmes, President and COO; and Mike Milligan, Vice President and CFO.

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, 2017.

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 ARR's Chairman and Chief Executive Officer, David Storch..

Thank you, and good afternoon all. Let me start by wishing everyone a very happy holiday season, and a great new year.

Q2, as you can see, was a solid quarter for the company as we increased sales and profitability on all of our Aviation Services businesses, began work on the INL/A contract and made solid investments that will support growth into the future.

We continue to gain momentum in our program business, and I'm exceptionally pleased with the progress that the recently added team has made. I'm also pleased with the opportunistic buys made by our trading team as we benefited from aircraft movement. We have unquestionably the best trading team in the industry.

We expanded our MRO network with the acquisition of 2 facilities in Canada that allows us to grow our relationship with Air Canada and others. In the Expeditionary services segment, we are very excited to have begun work on the INL/A contract. We are off to a great start.

Also in this segment, certain key contracts for USTRANSCOM rolled off as expected. Given where the opportunity is for us today, we are shifting resources and repositioning talent to focus on what is generally referred to as the government-owned, government -- contractor operated, or GOCO, service model.

As many of you know, the helicopter market has been under pressure the last 3 to 4 years, requiring us to take the impairment action we took. Our plan is to sell some of the assets and deploy some of the -- redeploy some of the assets as markets dictate. So with that, what I'd like to do this call to -- turn the call over to John.

John will be followed by Mike, and I'll wrap up the commentary before we open for questions and answers..

Great. Thanks, David. Good afternoon, everybody. As David mentioned, our Aviation Services segment performed very well during the quarter with a sales increase of 13% and $346.7 million to $391.6 million. Gross profit margin in this segment also increased from 16% in the prior year's quarter to 17% in the current year.

I'm exceptionally pleased with our sales growth to commercial customers which came in at 20%, as we benefited from the successful ramp of our program contract, growth in our part supply businesses and expansion of our MRO network. During the quarter, we announced a few new business wins as well.

They included 2 contracts that we signed for heavy maintenance services with Air Canada. One of those was a 5-year contract covering their 767 Suite, and that's work that we are going to be performing down at our Miami facility. We signed a second contract also with Air Canada, 10-year deal covering Air Canada's A320 family and E-190 fleet.

This work is being performed at our newly acquired Canadian facilities, and I should mention that the integration of those facilities are actually going very well, and we've already delivered several aircraft on time to Air Canada under this contract.

We were also awarded -- also an MRO, a long term contract with Republic airline to perform heavy maintenance on its fleet of 188 Embraer 170 and 175 aircraft. And I am sure most of you know they're a co-share partner to United American and Delta supporting their operations with that fleet.

As many on you know, the government markets as David mentioned in support of troop movements continue to be soft. And as a result, we have experienced decreased positions in our company-owned, company-operated, or what is generally known as COCO business, over the last few years.

As David mentioned, we are excited to begin work on the WASS program, and are taking action to reposition our resources in order to focus on more contracts like WASS, where we operate government-owned assets.

As David indicated, this business is generally known as government-owned, contractor-operated services, or GOCO, and we plan to pursue more contracts of this nature going forward. With that, I'd like to turn it over to Mike Milligan, who will talk about the financial results in more detail..

Thanks, John. Good afternoon, everybody. I'll discuss the company's Q2 fiscal '18 financial performance in more detail. We experienced increased sales in the quarter of $449.7 million, up 6% or $25.9 million from the same period in the prior year. Our sales growth was driven by strong performance in our Aviation Services segment.

Sales at Aviation Services increased $45 million or 13% year-over-year. The $391.6 million from sales growth in integrated solutions, including supply chain, MRO services and parts and supply -- parts supply, which more than offset the reduced year-over-year sales from the KC-10 contract of $20 million.

We experienced the sales decline in Expeditionary Services as indicated in the release. Gross profit in Aviation Services increased $10 million to $66 million in the quarter from operating gains in maintenance services, trading and distribution.

While the gross profit in Expeditionary Services was negatively impacted by the noncash impairment charges and the contract completions in the period. SG&A expense of $54.8 million included $4 million of the noncash impairment charge, increased legal costs related to the INL/A, contract defense and deal related costs.

Excluding these costs, SG&A expenses were more than 11% of sales. We have historically been in the 10% range for these costs compared to sales. We'll share our plans of reverting to the historical levels in our Investor Day presentation in January.

Our consolidated reported net loss was $22.6 million or $0.66 per share in the quarter, which included the impact of the $34.7 million after-tax impairment charge. This noncash impairment charge represents the effect of the write-down of certain aircraft and related support parts.

As reported, our adjusted net income was $12.1 million or $0.35 per share, which included operating losses of $1.6 million or $0.03 per share in Expeditionary Services as we indicated. Capital expenditures for the quarter were $9.7 million and depreciation, amortization was $13.9 million.

During the quarter, we paid dividends of $2.6 million or $0.075 per share. As of November 30, $245 million remains available under the board-authorized share repurchasing plan. Thanks for your time. And I'll let David wrap up our prepared remarks..

Thanks, Mike, and thanks, John, from before. During the quarter, we continued to execute on our strategy to become the best, independent aviation service provider in the world. I am very excited about our progress, investments we've made, the team in place and the favorable markets.

And in closing, for those of you who may not know, there was a tax code changed recently passed, and we preliminarily estimate that the positive -- the impact on our company's fiscal '19 results will be somewhere in the range of $0.35 to $0.45 per share as a result of the change in tax rate.

We'll provide more detail for our fiscal '19 plan at our Investor Day in January. So thanks, so much for participating, and I look forward to any questions that you might have..

[Operator Instructions]. Our first question comes from Ken Herbert..

David or John, really nice growth in Aviation Services. And you specifically called out, obviously, some of the heavy MRO and programs business.

Can you provide just any more granularity how much of the growth in the Aviation Services in particular was MRO? And specifically, the incremental work with Air Canada and the facilities you've taken on versus maybe organic growth that you saw in programs and on the parts side?.

Ken, most of that growth is organic. There was approximately, if you look at the net level, about 3% came through acquisitions in that segment. But largely, it's -- it would be organic growth..

Okay, okay. That's great.

And then within that, can you just update us on sort of how the flydubai contract is going and the opportunity to expand that work as that airline obviously continues to take deliveries of Max aircraft in particular?.

Yes, thanks for asking about that. The contract is going well. We're live on -- there are two contracts the NG contract and the MAX contract. We're live on both. And we expect that our contract will be extended to cover the additional aircraft that they just ordered..

Okay, great.

And just finally, can you provide an update on what you view now as the fiscal '18 contribution from INL's specifically, now that, that's obviously kicked off and up and running?.

Okay, I think we'll be in a better position to discuss that at the Investor Day. We're -- it really early innings -- you know, like top of the first, I guess, in Ireland.

So why don't you give us a little bit more time on that?.

Okay. Got it.

So you're throwing out the first pitch, but I guess it's fair to say it's starting off as expected?.

Yes, yes. We're very pleased. And I believe, State department is very pleased as well. And we've seen that we've put a great team on the field..

Our next question comes from Larry Solow..

Just sticking with the INL tune, I know you don't want to get too deep into the weeds there.

But is it fair that, I guess, during the ramp-up period, it should be pretty much a breakeven for you guys? Is that how we should view that?.

Well, I would view is -- I'd view the contribution, the ramp is modest..

Okay, okay. Fair enough. But I think there's a -- right? It's -- you're paid on cost right, they're refunding you that, right? So it's not a -- okay. And then just on the -- expeditionary, and then we'll go back into Aviation services. Was -- if it's excluding INL, which obviously is going to change the numbers a lot. And maybe it'll be in both segments.

I don't know if that's been worked out yet.

But the profit level this quarter, was it -- was there actually some gross profit, excluding the charges? And is this sort of the level that we should continue now that Afghanistan is out of there? Or is there -- was it in part of the quarter? Was there other things declining?.

Larry, I think we're trying to indicate where our thinking is, right? In terms of where we're taking that business. I think you can see that, hopefully. And we'll be in a better position to comment, as I indicated, at the January Investor Day..

Okay.

Just high-level, obviously, you know this is the -- the INL, big contract and towards your strategy of the GOCO, other -- significantly other opportunities out there? Maybe not of this size -- not of this magnitude? And does the contract win, I guess, help you open more doors for you and get other opportunities?.

We believe so. Yes, yes. We believe so..

Okay. Aviation services....

Yes, go ahead..

Just get a little better feel for the growth in Aviation Services. It sounds like it's pretty broad based. The MRO and the trading business is obviously have -- haven't had the type of growth that programs and distribution have. And I am probably guessing, they probably weren't quite as high this quarter either.

But fair to say programs and distribution still driving the better portion of the growth? And then, part 2 of that question is the margin improvement, anything behind that? Timing? Mix? Sustainability?.

Yes, for the first question, in this quarter, we saw growth across the board. So the trading business, the distribution business, MRO and programs all contributed. So everybody had a good quarter.

And can you repeat your second -- second half of your question?.

Just on the gross margin. You had a nice improvement in gross margin. I think MRO is actually -- generally has a maybe a little bit of a lower margin too, historically. So just trying to get a little pulse on the improvement.

Was it just a mix? And is it a sustainable type of improvement? And what you're think of going forward?.

It was a mix. And each of the business, as I would say, showed a little improvement in the gross margin. So similar to sales, we saw growth across the -- improvement across the board there. And we do believe it's sustainable..

Our next question comes from Michael Ciarmoli..

This is actually Les [ph] in for Michael. Quick question on the $0.35 to $0.45 tailwind to tax. Can you walk us through how you get there? Somewhat of a bridge.

And also, how you handle the deferred tax assets and liabilities?.

Well, we basically are moving our effective tax rate in line with our estimates of where we think that'll be. The deferred taxes, we did not make an adjustment for that in that estimate, but we'll recognize that as we go forward in next year..

Okay, got it.

And then also, there's significant appointment of the Chief Digital Officer, can you kind of talk us through how this business is going? How it's evolving over the long-term? And where do you see the aftermarket services going?.

So as it relates to digital, there's a couple of ways to think about that. We're excited to get Andrew on the team. He is already -- we're already learning a lot from him. We're thinking about digital across the whole company. And it will impact different areas of the business in different ways. We're looking at it from really two standpoints.

One is a refresh of the way our systems work and the way our people interact with those systems to get them more efficient. And the second is using digital data analysis, et cetera, to drive traditional -- to drive sales of our traditional businesses.

So we've got a number of efforts underway to be more robust in terms of how we collect and analyze data to do better price thing and ultimately, capture more market share..

Got it.

And then I guess last one, on the general update on the industry trends, and as far as shop business expectations for 2018, any comment there?.

I mean in general, we see positive trends in terms of inputs..

I'd say, year-over-year, in 2018 would you expect it to be a stronger year than 2017?.

I think we'll talk about that a bit more in detail in January..

Our next question comes from Ben Klieve..

So first a couple, just kind of bookkeeping questions here. I had -- the KC-10 program in Q2 last year, I had $29.4 million as revenue. But, Mike, you said $20 million today. Is there....

You're right. It was $29.4 million. It's down to $9.3 million. It's down $20 million..

It's down. Got you. Okay, I apologize..

There still some revenue coming in. And so the difference is down $20 million..

Right. Got it, okay.

And then, another question regarding the Air Force Landing Gear Award, are you able to quantify the revenue contribution during the second quarter from that award?.

No..

Yes, we can quantify. There was none..

Yes..

None? Okay.

But the ramp of that contract is still, it's still on course? There is no issues with that contract so far? Everything is going all right?.

Yes, you're correct. It's ramping up or it will ramp up as expected and we'll start seeing contribution in the Q4 time period..

And so the announcement you made of, Andrew Kemmetmueller, I think it's really interesting. Looking forward to hearing more about that going forward here.

One question I have is, before you brought him on last week, what do you really feel was lacking in your digital presence before? I know you talked a bit about that, but I mean, what really drove the creation of this position? What was the big gap that you felt needed to be addressed?.

I don't know if I'd characterize it as a big gap. We felt that we have an IT organization in the company that we've had for a long time. And then the digital services group is about 18 months old. And they were really existing separately.

What Andrew's skill sets brings to us is the ability to have both of those organizations inside the company report to one person, because there's a lot of overlapping efforts. And we're looking to him to coordinate that. We -- at the MRO conference over in London a few months back, we launched a few of our new digital services.

We got a part store, so we're selling parts online. We got some portals that we put out to help our program customers. And Andrew has got a whole pipeline of ideas that we'll continue to add in that portfolio of digital products.

So bringing the digital team, the IT -- the traditional IT team together and continuing to come up with new ideas for digital innovation is what we're looking for from Andrew..

Got you. That's very interesting.

Last question for me and I'll jump back in queue here is the announcement with the Republic Airline, was that a -- is that a completely brand-new relationship or was that an expansion of an existing relationship?.

It's a new heavy maintenance relationship. We've had a relationship with Republic for some time..

Our next question comes from Josh Sullivan..

Just on the Aviation Service side, as you're doing your forecasting for the next year, you look at the power by the hour opportunities out there.

Is there any way to quantify maybe what's in the pipeline? Just trying to get an idea if there is more airlines out there looking for new suppliers, just given some of the advancements, the technology and the digital offering that you're putting out there..

It's a pretty mature product at this point. We continue to see a robust opportunity pipeline. And we can talk a bit about more about the number of opportunities at the January conference..

Okay, great.

And I guess, can you help us with any of the dynamics maybe around the wide-body MRO service work? Are you seeing any supporting trends possibly moving work back to North America? Is it your Rockford facility maybe built around that trend? You see any interest in that facility at this point?.

Yes, we continue to have interest in Rockford. We're doing work for 3 different customers up there right now. The big focus for us, in the MRO facility is attracting talent, technicians. And we are starting to see some pressure in certain markets on wages..

Our next question comes from Brad Evans [ph]..

Just a question on bookkeeping item actually. Is -- was there -- there was reference to a $4 million impact to the SG&A line.

And I am just -- I want to confirm that -- is that accurate and is that reflected in the $52.2 million ex-impairment SG&A line?.

Yes, there's 50 -- exactly. There is incremental $4 million in there, which included the SG&A piece and incremental legal and deal related costs..

Which will be considered non-recurring going forward?.

Yes, that's right..

And where we should tax like that it say 34%, 35%.

So that's about $0.08 hit to the $0.35 set number that you reported as adjusted?.

It sounds right..

Okay. So really true earnings power in the quarter is closer to the $0.43 than the $0.35, correct? If one were to....

If you backed out the exceptional items, it is correct..

Our next question comes from Larry Solow..

Just to confirm on Brad's question, didn't you already -- you already I thought backed out a portion of that, right? The $2.6 million impairment.

So it's only the $1 million, right? When you restate while you're backing out the entire $54.2 million charge, right? Included in that was $2.6 million in SG&A, right? So you adjusted for that already in your $0.35, if I am not mistaken? You only thing you didn't adjust for as the $1 million in legal fees, but the other portion of it unless I'm mistaken.

Hello?.

So the answer to the run rate -- so what you say is we would add another $0.03 to the $0.38 or $0.41..

$0.38 or $0.35?.

$0.38. So you got the $0.35, the $0.03 what we're indicating is the losses at the business. And another $0.03 on top of that for the one-off exceptionals in the SG&A..

So the $3.6 you referred to in the press release, and just to clarify, and sorry to be annoying but Brad [ph] that's a very good question. The $3.6 you referred to in the text is actually included in the $52.2 million.

And then you break out an additional $2.6 million, is that right?.

$2.6 million of the $3.6 million is included in the impairment..

Right. Okay, so that's in the $2.6 million, you already backed out? You backed out the $54 million or whatever the total -- right. So it's only the $1 million that you haven't already backed out? Okay.

That's right?.

That's right..

And I'm showing no further questions at this time..

Larry, just to be clear. So it's $1 million plus another $400,000 that we indicated.

So it's $1.4 million or $1.3 million that gets you to the $0.03, okay? Next question?.

I'm showing no further questions in the queue at this time..

End of Q&A:.

Okay. Thanks everyone and have a happy holiday. Be well. Bye-bye..

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