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

Kenneth Herbert - Canaccord Genuity Limited Robert Spingarn - Credit Suisse Lawrence Solow - CJS Securities Michael Ciarmoli - SunTrust Robinson Humphrey, Inc. Benjamin Klieve - NOBLE Capital Markets.

Good afternoon, ladies and gentlemen, and welcome to the AAR's Fiscal Year 2018 Third 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, Mr. David Storch. Mr. Storch, you may begin..

Thank you, and good afternoon to all. Q3 as you can see was another strong quarter for the company as both sales and profitability increased sequentially, and versus the prior year period. Consolidated sales increased 12% from $407 million to $456 million, while gross profit margin increased to 17% from 16.3% in the prior year's quarter.

We again experienced double-digit revenue growth in our Aviation Services businesses and benefited from investments we made in all of our supply activities. Our strategy driving sales growth across all of our connected businesses through our best-in-class aviation services on track.

Our differentiated capabilities provides the basis to continue on our existing growth trajectory as we progress through our long-term transformation. Our teams are focused on execution to drive efficiencies and profitability.

We expect this momentum to continue as we ramp up services on our recent contract awards, including the US Air Force Landing Gear PBL and the State Department INL/A Worldwide Aviation Support Services programs.

During the quarter, we continued on the INL/A efforts and expect to be at a full run rate by the end of fiscal year and the Landing Gear PBL will kick in, in the April -- in April or this quarter. So with that, I'd like to turn the call over to John, John will be followed up by Mike, and I will wrap up the commentary before we open for Q&A.

John?.

Great. Thank you, David. Good afternoon, everybody. As David mentioned, we had another solid quarter, especially in Aviation Services, which was led by strong performance in our industry-leading integrated supply chain solutions and parts supply activities. Within our Aviation Services business, sales increased 11.4% in the quarter over the prior year.

We continue to see significant growth in our trading business as a result of strong demand and also our leading market position. Our distribution business also performed well as previously announced OEM distributorships continue to ramp up.

The commercial programs group focused on executing on the large number of contracts we’ve secured over the last several quarters. MRO, the integration of our newly acquired Canadian operation is progressing well and the new sites have exceeded our expectations both financially and operationally.

Elsewhere, at two of our other MRO facilities we experienced some labor pressure as the market is tightening for skilled technicians. We are working to get a handle on this situation and we have a number of initiatives underway.

We continue to invest in each of these businesses to support the growth as well as to develop new capabilities such as digital enhancements, all of which will further strengthen our competitive position.

We are also focused on the ramp up, as David mentioned, of the Air Force Landing Gear PBL contract with our first job inputs in February and we will fully go live on this important program on April 1.

Within our Expeditionary Services segment, sales increased $5.5 million or 22.5% from the prior year primarily reflecting the continued recovery in sales volumes for mobility products business.

As previously discussed, as part of securing the WASS contract, we’ve been shifting our resources to focus on the growing -- on growing the government-owned, contractor-operated or GOCO business.

As a result, we’ve decided to perceive the sale of our contractor-owned contractor or COCO business, which was formerly included in the Expeditionary Services segment. These moves are designed to deliver world-class service to our government customers as we pursue more GOCO contracts going forward.

Regarding WASS, the transition is proceeding well and we’ve recently begun performing certain critical functions for the Department of State. Overall, certain transitional elements have compressed and we do not expect to see the full $50 million of transition revenue highlighted during Investor Day before we go live on May 1.

The WASS contract contributed less than $3 million of revenue in Q3, and we expect that to be about $25 million in Q4. As I mentioned, the program will go live on May 1, at which point we expect to be at full run rate and it will become a contributor to earnings. We are all very focused on delivering world-class service to the Department of State.

I do want to mention some other recent awards as well that we announced during the quarter. We announced a 7-year contract from the Naval Air Systems Command or NAVAIR for airframe maintenance and AOG support of the P-A8 fleet for the U.S Navy, Government of Australia and other foreign military sales customers.

AAR's work on the P-A8 Airframe which is a 737 derivative will be performed at AAR's MRO facilities in Indianapolis, Oklahoma City and Miami. This is an important contract win for us. It's our first with the -- with NAVAIR and the P-A8 fleet is large and growing.

We also announced during the quarter our new joint venture for the development of a heavy maintenance facility in Central India. This new MRO facility will begin operations in FY2019.

We’ve already been investing in this venture and expect investments to continue over the next several quarters and we’re really excited to bring our brand and know-how to this important and growing market. Overall, we have a lot of momentum and we’re feeling really good about our prospects going forward.

And with that, I will now turn the call over to Mike..

Thanks, John. Good afternoon. I will take a few minutes to discuss the company's Q3 fiscal '18 financial performance in more detail. We experienced strong sales from continuing operations in the quarter of $456.3 million, up 12% or $49 million year-over-year.

Our sales growth was driven by the $44 million sales increase in our aviation services segment, specifically in parts trading and distribution, commercial programs as well as MRO and Landing Gear Services. KC-10 sales were $3.6 million in the quarter, down $20.7 million from $24.3 million in the prior year and will have minimal sales going forward.

Our Expeditionary Services sales increased $5.5 million in the quarter. These sales increases were generated by our mobility operations and the startup of our transition services for the INL/A WASS contract.

Income from continuing operations was $31.3 million or $0.90 per diluted share impacted by a $13 million or $0.38 per diluted share tax benefit related to the estimated remeasurement impact from the U.S Tax Law changes.

Also, our provision for income taxes was favorably impacted by a $1.8 million or $0.05 per diluted share, estimated rate reduction to 30% from the current -- for the current fiscal year heading to 24% in fiscal year '19.

With the ongoing focus of improving the profitability of our business units, consolidated gross profit in the quarter increased $11.1 million to 17% or 17% to $77.6 million. Gross profit in Aviation Services increased $8.5 million or 13% driven by the strong performance of our parts supply unit.

Gross profit in Expeditionary Services increased $2.6 million from increased sales volumes and improved profitability at our mobility business.

SG&A expenses were 11.7% of sales during the quarter impacted by higher legal expenses and increased personnel related costs, including higher technology spending as well as early-retirement severance charges of $1.1 million or $0.02 per share.

Capital expenditures for the quarter were $4.8 million and depreciation and amortization were $10.6 million. Our net interest expense for the quarter was $2.2 million compared to $1.3 million last year due to higher average borrowings during the quarter and an increase in the underlying interest rate.

We will continue to focus on improved cash conversion, increased liquidity, and ample availability to take advantage of market opportunities. To provide additional financial flexibility, we entered into an accounts receivable working capital facility of up to a $150 million.

Our cash from operations -- cash flow from operations were positively impacted by this accounts receivable, off-balance-sheet financing which generated $52 million in the quarter.

During the quarter, we returned $10.4 million to shareholders through dividends of $2.5 million or $0.075 per share, and share repurchases of $7.9 million or approximately 201,500 shares. Average diluted share count for the quarter was 34.5 million compared to 34.2 million in the third quarter of last year. Thanks for your interest.

And I will turn the call back over to David..

Thanks, Mike, and thanks, John. As you can see we had another great quarter for the company. I’m very excited about the future given the investments we've made in the leadership team that we have in place. In closing, we're affirming our guidance of fiscal 2019, which we previously announced at our Investor Day, in January.

This guidance includes sales in the range of $2.1 billion to $2.2 billion, diluted earnings per share from continuing operations in the range of $2.50 to $2.80, and adjusted EBITDA in the range of $180 million to $190 million. We also expect Q4 to be an improvement over Q3.

With that, I will turn the call back to the operator for any questions you might have. Thank you..

Thank you. [Operator Instructions] Our first question comes from Ken Herbert with Canaccord..

Hi. Good Afternoon..

Hi, Ken..

Hi. I wanted to see, Mike or John or David, for the INL contract, it seems like the ramps may be a little slower than you’ve been expecting? I can appreciate there's a lot here to get this going.

But can you -- aside from what you provided here for the remainder of the estimate here for the fourth quarter, are you still on track as part of the reaffirm the full-year '19 guidance for what you talked about is the INL contribution and can you just talk a little bit about the ramp and how you see that progressing through '19 and again the overall numbers or overall contribution you’re expecting from the contract in fiscal '19?.

Sure, Ken. It's John. I wouldn’t describe the ramp is slower. I would describe it as more compressed. In other words, when the original task orders associated with the $50 million was put out, there were some assumptions made that certain functions would be taken over by AAR over time.

The way State has worked with us and laid it out, those functions are really all going to be taken over in a very short period of time at the end of the transition period.

And once those are taken over, we go live officially on the whole program on May 1 and at that point we expect to be at full run rate which is consistent with the numbers we presented in January..

Okay, great. Thanks. And if I could just one follow-up on Aviation Services, I mean you are still seeing very good growth.

It sounds like on the parts side of the business, can you just provide any more color specifically on the parts trading and distribution, maybe where you are seeing the growth? Are there any particular aircraft types or engines that you see the lot of activity in, and I guess -- now the comparisons and you start to anniversary, your laps are much more difficult, comps how are you -- how do you see growth through the remainder of this year into fiscal '19 for those businesses within Aviation Services? Thank you..

Sure. Thanks. John, again. Really the growth in the parts businesses has been across the board, both in the trading on the engine and airframe side as well as in distribution across multiple of our distributorship line and that covers -- and in distribution that covers both the commercial and government markets.

So we’re really seeing increased demand all over. There's a couple of new programs that we have signed in those businesses that we expect to continue to ramp over the next several quarters. So we remain confident right now about the continued growth in those businesses..

Okay, great. Thank you very much..

Thank you. Our next question comes from Rob Spingarn with Credit Suisse..

Hi. Good evening.

What’s the sale of the COCO business, what contracts are going with that? And I assume all the assets whatever aircraft are left, could you just walk through that a little bit?.

Yes. So we don’t have a sale, per se, at this moment, but we will be putting the businesses up for sale. And the contracts that are associated with that business are no longer reflected in our sales numbers..

Okay.

And then, if you could just clarify, with regard to the out -- your guidance to the '19 guidance, that that stays the same despite this decision?.

Yes, correct..

And why is that? If you hadn't come to this conclusion ….

We are seeing good growth in our businesses, and we feel good about the prospects for hitting those targets that we established..

So the retained business has improved to offset the loss of the contribution from the sold business or the potentially -- the discontinued business..

So the revenues are we feel that we can pick up the revenues through the growth of our other businesses and the contribution margin from the business that we are looking to sell has been negligible..

Okay. All right.

So at least from an EBIT perspective that makes some sense, although if the other businesses are ….?.

Yes, we’ve been -- Rob, so to be clear, we’ve been transitioning our interest and our energy around this new contract which is obviously a very meaningful piece of business for the company. And we’re eager to commence work on this contract and have gone ahead and reallocated our resources to make certain that we’re successful in this regard. So ….

So just -- that’s what you’re seeing here..

Yes, I just want to make sure I understand this though. So if the sales are an offset, you lose the COCO sales, you offset that pretty much wholly with better growth in the existing businesses.

I assume you mean Aviation Services, primarily along with the GOCO business which are profitable and you’re losing profit list sales, shouldn’t there be higher profit next year?.

We are -- you’re asking what the -- you’re asking in relationship to the expectations that we established at the Investor Day. And but we’re saying it's yes to your question about should we expect more profits last year [ph], I think you can see by the numbers that we’re putting out there that will be significantly more profitable next year..

Not more than last year. More than your initial expectation for '19..

Excuse me, excuse me. I -- Rob, the answer is that we will be much more profitable next year than we’re this year. And we will -- we are forecasting that. We’ve communicated that. And that’s what we’re expecting..

Okay. I will ask you the question offline. With regard to the 18% growth that you saw in the quarter X KC-10, in aviation services. Can you talk a little bit more about how that trended throughout the businesses. I think John the answer to that question, I think we’ve had consistent growth across all of the businesses in that segment..

Okay. Thank you..

Thank you. Our next question comes from Larry Solow with CJS Securities..

Just a few follow-ups from that. The -- it sounds like the MRO piece this quarter maybe under organic basis. Didn’t quite grow as fast as the other pieces that’s fair to say..

Yes, I think that’s a -- I think that’s fair to say..

Okay. Okay. And then just -- so just to clarify not to beat the diverse, on the COCO peats that you’re selling this quarter -- you know that you know just selling. Its profitable or not profitable. Its negligible in a way, but it sounds like I think your last quarter it was a little bit of a pain to earnings.

It's fair to say this quarter it would have been negative turnings, so, yes, you pulled the way a couple of cents that would have actually been negative?.

I think that’s a good way to look at it, yes..

Right, and so then your -- whatever maybe '20, I don’t know if I can quantify the sales impact, but we can do it offline. Okay. Just -- and then, I guess, those are the remaining Expeditionary Services at this quarter, essentially is really just mobility and the $3 million of INL revenue..

Slightly less than $3 million of INL and mobility, that’s correct. .

Okay. And then was there some SG&A was a little higher than I thought it would be. I know there was a $1 million of severance there.

Was there some expenses for INL, was there some stuff in front of the Landing Gear contract? Any other reasons for the SG&A number being a little high?.

Yes. In both regards the answer is yes. More so in INL, but yes increased expenses in preparation for INL/A..

So the INL is actually -- you actually have lost dilutive this quarter?.

No, I won't say dilutive, but I won't say it was -- it was not additive..

Okay. So probably those $3 million [indiscernible] $3 million in sales. Okay, sounds good. Thanks. I appreciate it, David..

Yes..

Thank you. Our next question comes from Michael Ciarmoli with SunTrust..

Hey, good evening, guys. Thanks for taking the questions.

Just on sticking to this -- the COCO piece, what was the revenue run rate, the annual revenue run rate of the business that you’re going to try and sell here?.

For which period are you referring to? Because the business went through a steady decline, if you will.

So which period would you like us to address?.

I guess what ….

Would you like to discuss that offline?.

Well, I mean, I just get back-- getting back to Rob's question, I mean, I will pick round numbers here.

I mean, if you’re swapping out $35 million or $40 million of no margin business and you’re making it up with $35 million or $40 million of higher margin aviation business, profitability will be greatly improve yet next year, yes, but it seems like there should be some potential incremental upside to the earnings guidance.

And I think that’s kind of -- again, swapping out lower margin revenues with higher margin, do we see some potential upside to that earnings number that you’ve kind of laid out already and reaffirmed? I think that’s what we’re trying to hit on..

Yes, so keep in mind then the earnings guidance we are giving you a range, right. I mean, you got a range in that regard. So I’d say this action strengthens our confidence, let's say in the potentially higher end of the range..

That’s perfect. And then, maybe just you touched on the labor pressure. Can you just elaborate, I mean, we’ve certainly got -- there's a lot of growth in the aftermarket, there's certainly more planes coming into service on a regular basis here.

Is this something -- I think you talked about some initiatives, but can you pass these rates through to the end customer or maybe just elaborate a little bit more on that dynamic?.

Yes, sure. It's something that has been going on for some time, and this is certainly an industry dynamic not just an ARR dynamic and -- and right, so we’re -- we’ve a number of recruiting initiatives going on.

We have internal training initiatives where we’re taking some of our more experienced workforce on certain sites to import to other sites to train up newly [indiscernible] technicians. And then on the wage side, there are certain levels in the organization where we’re looking at compensation adjustments.

And then on a broader sense, we’re already in dialogue with certain of our customers about potentially having to adjust pricing as a result of the wage pressures. And the customers are very aware of this..

Got it.

So no immediate push back? I mean, it sounds like they are receptive to some of these price increases?.

We started the conversations and they all understand the dynamic and we’re a very important provider to them and an important part of the supply chain and they want to make sure that we’re successful..

Okay, got it. And then, last one, just on the INL contract. I think you talked at the Investor Day about $200 million to $225 million, but potentially talked about there could be room for some scope increases there.

How are you guys thinking about sort of the annual potential even if it's not '19 beyond '19, do you see more runway for opportunity on that contract as you start to get up to full rate?.

We do. I think we’re in the exact position in that regard as we were at the Investor Day. The only thing that really changed as I mentioned was that the timing of certain events during the transition period..

Got it. Got it. All right. Outstanding. Thanks, guys. I will turn back in the queue here..

Thank you. [Operator Instructions] Our next question comes from Ben Klieve with NOBLE Capital Markets..

All right. Thank you. A few questions here. First regarding the mobility business. I’m curious with this being a greater and greater relative contributor to us in the top line, if you could elaborate a bit on the level of fixed cost in this business now that the segment is growing.

And kind of what we can look at from an operating margin perspective from that segment?.

Can you repeat the question, Ben? You’re cut out..

Yes, I’m sorry about that.

So in the mobility business was it being a greater and greater contributor on the top line? I’m curious if you can elaborate a bit on the level of fixed cost in that business? And then, the margin -- the operating margin potential in that business as it theoretically continues to grow here going forward?.

Well, the business although it’s up on a year-over-year basis, it is not approaching historical levels at this time. In terms of the fixed cost to support that business as that business does continues to see growth. We don’t expect much in the way of additional costs.

So as this business receives contracts, it is a pretty profitable activity for the -- its a very profitable activity for the company..

And so -- and you ….

Yes, go ahead..

So you've crossed threshold or breakeven for this business then ….

Yes..

… so -- okay, perfect..

Yes..

And then a question regarding the India MRO facility, so first, John, I didn’t catch what you said regarding the date in fiscal 2019.

What was your comments around that date?.

Yes, late in 2019 or into fiscal 2019 is when we anticipate being inducting our first aircraft..

Okay, perfect. Thank you. And then, so looking in the late '19 or 2020, I’m curious if you can just elaborate a ....

Sorry, go ahead..

… elaborate a bit more on the -- I’m curious, if you can just elaborate a bit more once that facility is up and running. It really -- I’m -- it sounds like a very high ceiling opportunity.

I’m wondering if you can help us kind of understand what you see as the opportunity there from that facility?.

Sure. So it's the narrow-body facility, we are in negotiations with two different baseload customers. We would have between four and six lines of narrow-body maintenance. Currently those customers are sending their work out of the country, so they’re interested in bringing that work back in the country to bring jobs to India.

We hope that we would be in a position to announce those contracts here relatively soon. And that -- in these two phases of the facility planned, the first investment phase is one hanger like I said can take up to six narrow-body lines.

The second phase would be a similar size hanger that would be able to take another four to six lines on the same-site. We’ve secured land to be able to construct both facilities and just to go back we do expect to be able to conduct our first aircraft in the middle of FY19..

Perfect. Okay that’s really exciting. Its -- that’s great to hear. That does it for me. Thanks so much for taking my questions. I will get back in queue..

Thanks, Ben..

Thanks, Ben..

Ladies and gentlemen, thank you for participating in the question-and-answer portion of today’s call. I would now like to turn it back over to management for any closing remarks..

Well, thank you very much for today’s questions and hopefully we were helpful. I wish everybody a nice evening, and speak to you soon. Bye-bye..

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