AAR Corp.

Good afternoon, ladies and gentlemen, and welcome to AAR's fiscal 2020 fourth quarter earnings call. We are joined today by John Holmes, President and Chief Executive Officer, and Sean Gillett, Chief Financial Officer. Before we begin, I would 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 the company's News release and the risk factor section of the company's Form 10-K for the fiscal year ended May 31, 2019, and Form 10-Q for the fiscal quarter ended February 29, 2020. In providing the four looking statements, the company assumes no obligation to provide updates to reflect future circumstances or anticipated or unanticipated events. At this time, I would like to turn the call over to AAR's President and CEO, John Holmes.

Great. Thank you, and good afternoon, everyone. I really appreciate you joining us today to discuss our fourth quarter in our full year 2020 results. Before we get into those results, I'd like to begin by thanking the AAR team for its truly remarkable strength during these unprecedented times. In many cases, we have had to make difficult decisions in order to align our costs with a lower-demand environment. and I'm really proud of my teammates for their professionalism and resilience as we work through the impact of COVID-19. I also want to thank our customers for their unwavering support and for recognizing the unique value that AAR continues to bring. In addition, I'd like to comment on diversity and inclusion. These imperatives have been part of AAR's core values for decades. We have a long history, both internally and within our communities, of supporting and promoting underrepresented groups. However, the events in recent months have prompted us to broaden our efforts to try to understand systemic racism and discrimination and determine how we can continue to improve as a company and as a society. To that end, we are taking several additional steps that will enable us to rebuild our workforce with an even more diverse team as our industry recovers. Much as AAR has played an industry-leading role in addressing the shortage of skilled labor, so too can we play a role a leadership role in building a more diverse and inclusive aviation workforce at all levels in the industry. With that, I want to turn to our results. As you all know, the commercial aviation industry has been significantly impacted by the COVID-19 pandemic. In light of the challenging environment, I'm very pleased with our overall performance. Our sales for the year grew 1% from $2.5 billion to $2.07 billion, and our adjusted diluted earnings per share increased and continuing operations decreased 12% from $2.44 per share to $2.15 per share. Although our earnings for the year were down from 2019 levels, our results reflect three quarters of record sales and earnings performance and a fourth quarter in which we were able to effectively navigate a historic decline in the commercial aviation industry due to the unprecedented grounding of the world's fleet. Sales for the fourth quarter were down 26% from $563 million to $417 million, and adjusted diluted earnings per share from continuing operations were down 62% from $0.68 per share to $0.26 per share. We took numerous cost reduction actions early in the quarter to offset the impact, which we described in our May 21st H8K, including facility closures and consolidations, exiting unprofitable product lines, and exiting or restructuring underperforming commercial programs contracts. These resulted in a pre-tax charge in the quarter of $27.9 million and bring our cost structure into much better alignment with the current revenue base. In addition, our agreement to divest our composites manufacturing operation, which we announced a few weeks ago, was not profitable in FY20, and does not quarter our aviation services offering is a step towards further enhancing our profitability. We had launched the sale process earlier this calendar year and are pleased to have agreed on a transaction that furthers our multi-year strategy to focus on our industry-leading aviation services and reduce complexity in our operations. All of these actions, along with the actions we are continuing to take in the current quarter, produce permanent changes in our cost structure, which we expect to improve margin as our revenue recovers. Even in this environment, we continue to pursue and win new business, and I want to highlight a few examples. During the quarter, we announced an agreement with BASF to distribute and maintain certain aircraft cabin air quality improvement products, as well as a $125 million sole source contract with the U.S. Air Force to produce and repair 463L cargo pallets. We also announced a joint venture with Sumitomo to provide supply chain solutions to the Japanese defense market and to distribute parts from Japanese OEMs to the global aftermarket. In addition, subsequent to the quarter, we announced an extension and meaningful expansion of our agreement with Unison Industries, a subsidiary of GE Aviation. In this agreement, we serve as its exclusive worldwide aftermarket distributor for aviation, military, civil, and land vehicle products. The agreement also includes repair services and is valued at more than $1 billion over 11 years. This award demonstrates the value of AAR's distribution model and connected business strategy, as well as our ability to use our relative strength to extend and grow our business during the pandemic. Before turning it over to Sean, I also want to touch on the expected agreement we announced yesterday with the U.S. Treasury under the Air Carrier Worker Support portion of the CARES Act. Under that agreement, we expect to receive $57.2 million to pay salaries, wages, and benefits to the workforce and currently employed in our U.S. Airframe landing gear MRO operations. Of the $57.2 million, $48.5 million is a grant, and $8.7 million is a low-interest, pre-payable note. As you know, over the last two years, we have worked to successfully build a technical workforce for AAR, and we have launched initiatives to bring new talent into our industry. This grant helps ensure that those efforts will continue, and I really want to thank Congress and in particular the Illinois, Oklahoma, Indiana, and Indiana delegations, as well as the administration, for recognizing the essential services that our employees provide to the commercial aviation industry. With that, I'll turn it over to our CFO, Sean Gillins.

Thanks, John. Our sales in the quarter of $416.5 million were down 26% or $146.2 million year-over-year, including a $7.5 million impact related to the exit of certain contracts. Sales to government and defense customers were 47% of consolidated sales versus 35% in the prior year quarter as our commercial activities were significantly impacted by COVID-19. Specifically, our commercial sales were down 40% year over year. As John mentioned, we took a number of steps in the quarter to reduce our fixed costs and overhead, including closing our Goldsboro and Duluth facilities and exiting or restructuring underperforming contracts and product lines, primarily in our commercial programs business. These actions resulted in a predominantly non-cash charge of $27.9 million, which is recorded in the P&L as a reduction in revenue of $7.5 million, an increase in the cost of sales of $15.7 million, an increase in SG&A of $2.8 million, and a loss from joint ventures of $1.9 million. We are continuing to take additional actions in Q1 to reduce costs and improve margins. These include the composites divestiture, as well as continuing to address underperforming programs and additional footprint rationalization. We estimate that all of our actions will reduce ISG&A by over $50 million on an annualized basis, and we will remain disciplined about maintaining these cost savings, enabling margin expansion as demand recovers. Gross profit margin in the quarter was 8.7% versus 16.8% in the prior year quarter. Excluding the charges, gross profit margin was 14.1% versus 17.0% in the prior year period, which reflects $0.9 million of adjustments in the prior year period related to facility repositioning costs. Aviation services gross profit decreased 53.2 million. Our government business across parts, repair, and integrated solutions remained relatively stable, and we were able to emphasize our cargo end markets. However, demand in our commercial airline businesses was down as a result of the pandemic, including in both parts and maintenance services. Within our heavy maintenance business, although we began the quarter with full hangars, work slowed throughout the quarter and remained at reduced levels, which we expect to continue during our seasonally low Q1. In expeditionary services, gross profit decreased $5.1 million. We expect performance in this segment will improve as mobility executes on the Air Force pallet contract, and we complete the divestiture of composites. SG&A expenses were $47.3 million for the quarter. Adjusted SG&A was $46.5 million, down $10.8 million from the prior year quarter. This reduction was primarily driven by the COVID-19-related overhead cost actions we took. During the quarter, we elected to draw the remaining available balance under our revolving credit facility as a precautionary measure, which resulted in net interest expense increasing 0.5 million to 2.6 million. We expect to repay the facility this quarter such that we maintain cash on hand going forward consistent with historical levels. In the quarter, we used 18.6 million of cash in our operating activities from continuing operations. primarily due to a decrease in accounts payable, partially offset by a decrease in accounts receivable, contract assets, and inventory. Also during the quarter, we returned $2.6 million to shareholders via a dividend of $0.75 per share. As a condition of accepting payroll funding from the U.S. Treasury under the CARES Act, we are not permitted to pay additional dividends through September 30th of 2021. Our balance sheet remains strong with net debt of $197.3 million. and net leverage of 1.3 turns. We have no near-term maturities, and as of the end of the quarter, we had unrestricted cash of $404.7 million. With respect to the CARES Act funding, we expect to receive the funds during our fiscal first quarter. Upon receipt, we will record an increase to unrestricted cash and corresponding liabilities for labor costs pursuant to the grant portion and for the unsecured note. The benefit will flow through the P&L. Specifically, as we incur salary, wages, and benefit costs in our U.S. airframe and landing gear operations, we will offset the expense on the income statement until the funds are depleted, which is expected to take approximately two to three quarters. Similar to other government workforce subsidies, we will exclude the income from our adjusted earnings. Acceptance of the funds does not undo any of the cost actions taken in the fourth quarter. Thank you for your attention, and I will now turn the call back over to John.

Great. Thank you, Sean. Despite the impact of the COVID-19 pandemic, we are pleased with our Q4 and full year results, and I'm proud of the courage and dedication of our employees. Our government business continues to be healthy and growing, and we are having success placing more emphasis on our cargo and markets. When the environment continues to be very dynamic, our commercial airline businesses have performed better than expected as a result of the early cost actions that we took in the quarter, as well as our deep customer relationships. In addition, Our liquidity and balance sheet remains strong, which we view as a competitive advantage, allowing us to secure new business. Our Unison one is a great example of this. However, we remain very focused on generating cash to preserve and enhance our liquidity position. We expect to continue to make structural changes to our portfolio, which, when combined with the actions we have already taken, will improve the margins of the company as we recover. That said, the duration of the crisis remains very uncertain. and for that reason, we are not providing guidance for FY21. We do expect sales in Q1, which is typically our lowest quarter based on seasonality, to be down sequentially from Q4, consistent with prior years. Overall, we are confident in our ability to navigate the current environment, and we believe we have an opportunity to use our relative strength to emerge from the crisis even stronger, more profitable, and better positioned for long-term growth. With that, I'll turn it over to the operator for questions.

Thank you. Ladies and gentlemen, if you have a question at this time, please press star 1 on your telephone. Again, that's star 1 on your touch-tone telephone to ask a question. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Robert Spengard of Credit Suisse. Your line is open.

Hey, good afternoon, John and Sean. I understand that this is a dynamic time, yeah, and obviously very difficult. One of the things I think would be helpful for investors is to see if we can figure out where trough is. And so in the context of your 40% decline in commercial, how do we think about the months in the quarter? And then you talked about this sort of seasonality on a sequential basis, but Have you troughed, and can we talk about that separately for MRO versus parts?

Yeah, sure, good question. So from a parts standpoint, you know, we felt the decline very early in the quarter. And I think the levels that we're at now, which are, again, better than we expected, have been holding the last several weeks. And, you know, given the dynamic of the environment, it's difficult to call anything a trough. But, you know, we saw a decline, and they have been holding steady for the last several weeks. Now, obviously, there's a lot of movement out there, particularly with the North American carriers in terms of, you know, the results of the recent surge and changes they may be making to their fleet. But, you know, so far, the last several weeks, the parts businesses, both distribution and trading, have held in there. For MRO, you know, throughout the quarter, We started the quarter with full hangars. And then throughout the quarters, we delivered aircraft. In many cases, those aircraft were not replaced by an additional aircraft. So we did see decline through the quarter. You know, we are at a depressed level heading into the summer from where we would normally be. But, you know, seasonally, it's typically a low quarter for us. As it relates to MROs, We have a lot of dialogue with the customers right now about what the fall is going to look like, and I would say that's a very dynamic discussion. We're not yet clear on what the fall maintenance schedule will be, but, you know, we're confident that the customers are focused on keeping our facilities as full as possible because they want to make sure that, you know, they're available to them as they see a recovery. All right.

Okay, and then, you know, thank you for that. I'd like to dig in a little bit in terms of how the customers are thinking about this. One of the ways that we look at it is the size of the park fleet. So I guess the park fleet got up to about 16,000, 17,000 aircraft early on in this thing and now has dipped below 10,000, so that's good news. Has that translated into more business, or are those aircraft that are coming back in not in need of maintenance? Yes.

We haven't seen it translate yet, but we do expect that there is a backlog of maintenance requirements that's building out there. As the airlines look to manage their cash, we expect those maintenance events to convert. We do view that, though, with respect to potential retirements and the introduction of new aircraft into the fleet, and I think those dynamics are still playing out.

Okay. One other thing I wanted to ask you about was part outs and what, if anything, is happening there.

Yeah, so haven't seen a tremendous amount of activity there, but certainly that's something we're looking at closely. You know, if you think about the growth in our trading business in particular over the last several years, the constraint really to growth has been, and we did grow, but the constraint to further growth has been availability of material. So we are looking forward to opportunities to part out aircraft and bring more material to the market and capture a greater percentage there. The other thing that we expect to see as we go through this, and our sales force is working very hard on this, As airlines that may not have been historical users of used serviceable material, given the pressures on cost, we may see more conversions of customers that typically had been OEM buyers look for alternative sources like USM. So as more material comes on the market, as well as we can convert more customers, take advantage of the cost savings that come with buying USM, We expect to see, you know, growth and recovery there.

And on that point on material coming to the market, you just said that the supply of materials is an important driver. Is that just not happening yet because those who own the aircraft aren't yet sure what they want to do with them?

Yeah, I think that's a fair assessment. And, you know, just because aircraft are parked or retired does not necessarily mean they're going to go straight to part out. You know, that takes time. And there is, you know, only a certain amount of available capacity out there in the market to part out aircraft. So, you know, there's a lot of factors at play in terms of how that new material or how that new material hits the market.

Okay. Thank you very much. I'll step out.

Thank you. Our next question comes from Joseph DiNardi of Stifel. Please go ahead.

Hey, good afternoon. John, just maybe along the lines of Rob's question, can you just maybe level set where things are now? Like what was the commercial business down in June or kind of where is it running now?

Yeah, I don't know that we want to necessarily comment on individual months, but, you know, we saw throughout the quarter we saw a 40% decline, you know, in total. And certainly that, you know, accelerated, you know, between March and May. But the levels that we are seeing in June are slightly – or saw in June and are seeing in July are slightly better than what we saw in April and May, but still at a depressed level. So we're holding at the current position for the time being.

Okay. Okay. And then maybe just kind of – some more clarity around kind of the nature of your conversations with some of the airlines. I would imagine that some of them are obviously now under greater financial pressure, would be more interested in shifting risk and capital onto your balance sheet and taking advantage of that. Is that starting to present itself as an opportunity or not yet? And do you see that eventually as becoming one?

Definitely see that potentially coming out from the airlines. We actually already are seeing it from the OEMs. So in the distribution business, there's been a lot of discussions with OEMs at all levels in the supply chain of looking to your point to take advantage of our relative strength in exchange for long-term distribution agreements. You know, we are exceptionally focused on our liquidity position and our cash position, so we're considering those deals very carefully, but we do view that as an opportunity to add strength to the distribution business, which has been a great success story for the last few years.

Okay, and then maybe along the lines of the MRO business coming back, are you getting any kind of unusual requests from airlines in terms of, how that work is financed? Are they asking you to extend them on unusual terms given their liquidity relative to yours?

We went through a number of those discussions several months ago early in the quarter in terms of looking at extended terms for our airline customers. And that was pretty much, I wouldn't call that necessarily unusual, it was pretty much a universal request from all of our partners out there. And we, you know, in turn, we, you know, flowed that down to our supply base as well. So we have extended terms to our customers, and we've received extended terms from our supply base. And, you know, beyond that, we haven't, you know, seen any requests that I would consider unusual. Okay. Thank you.

Thank you. Our next question comes from Michael Ciaramoli of SunTrust. Your question, please.

Hey, good evening, guys. John, Sean, thanks for taking the questions here. I know maybe I'm not sure if this is John or Sean. I know you guys aren't going to give, you know, any specific revenue guidance for the year, but I think you talked about taking, you know, $50 million of SG&A out of the business, you know, probably implies $170 million. You know, is it fair to say you're sizing the business for maybe a $1.6 billion, you know, revenue run rate? You know, just thinking about kind of how you've been running at SG&A, is that a fair bogey to think about?

I wouldn't think about the SG&A target necessarily in the context of revenue sizing. I would think about the SG&A target in, you know, really around improving our margins. As you can tell, we're taking a lot of action today. during this period of time, and we're taking quick action to really change the structure of our cost base, as Sean mentioned, in many cases on a permanent basis going forward. We've had a number of margin improvement targets for a long time, and we're really using this time to accelerate our efforts in that regard. I don't know, Sean, if you want to.

Yeah, I would just add, Mike, my comment was, you know, over $50 million, and it's across ISG&A, so indirect spend as well as SG&A. I just wanted to clarify that.

Got it. Got it. And then can you just talk about, you know, kind of talk about some of the conversations with the airlines. But, you know, can you maybe talk to some of the integrated program, the power by the hour contracts? I mean, it seems like we're going to be in an environment here of reduced flying hours for quite some time, I think. You know, United just said they expect 65%, you know, capacity, you know, through this third quarter here. You know, what are the implications on those, you know, existing contracts you have with your broad airline customers?

Yeah. So we also are prepared for an extended period of the press line. And, you know, that's the way we're modeling the business and the way we're sizing the business. As it relates to... commercial programs in particular, you know, that's a business that, you know, you did see significant decline in that business right away because just by definition you bill based on flight hours, and many of those customers had grounded nearly all of their fleet during the period of time. You know, as Sean mentioned, we did take some charges in that area because, you know, those contracts, to the extent that – They are flexible enough to work in this environment. We leave them in place to the extent that the contract will not match the customer's operation or our requirements going forward. We're looking to restructure and stay with that customer. But in some cases, we've chosen to exit an agreement. And, you know, as we've talked about for the last couple quarters, you know, that business, even before COVID, had been under pressure due to market dynamics and changes in cost in the supply chain. And, you know, once again, we're taking this opportunity to restructure that business so that when we come out of this, it's much more profitable going forward.

Okay. Got it. That's helpful. And then I got one more here, and then I'll jump back in the queue. You know, inventory levels were up. You know, if I think about, you know, just the total lack of flying, you know, someone like United's capacity is going to be down 65%. How do you think about burning down inventory if there's just a complete lack of flying hours, a lack of pull on any inventory in the broader supply chain if distributors are fully stocked? I mean, does this become a little bit problematic to move inventory if there's just not a lot of consumption out there? I mean, how are you guys thinking about maybe converting that inventory into cash under this depressed environment?

No, great question. And converting inventory to cash is a very top priority for us. You know, you saw the inventory come up because, you know, pre-COVID there were a number of agreements that were signed that had investment requirements. And we, in almost all cases, lived up to those commitments to our partners, particularly in the distribution business. So that drove a lot of the inventory increase. We feel good about the position that we have. We feel good about the parts that we carry. The parts in particular in the commercial programs business, you know, those are by definition for those parts, the higher moving, higher consumed parts, just the way those contracts work. So it is material in a normal environment that would be high demand. But as you point out, we are not in a normal environment. So we are redoubling our efforts to market that material very effectively, get creative in terms of trading material that we have against other services that may be required from the customer base, and looking to move it as best we can. But there's still, as we keep saying, a great deal of uncertainty out there in terms of how the overall fleet will unfold And we may see certain asset classes where we would have expected, you know, a shorter life to actually get extended because new aircraft deliveries aren't going to occur. So we're watching that as well. And I do want to mention the point that I made to Rob Springer's question just around another effort we have underway is to convert customers to USM. This is a great time to, when there's material available, you know, particularly on our shelves and in the market, to really tout the benefits of buying used material that is often available at, you know, 30%, 60%, 70% of lists, you know, to customers that actually do have demand. Got it. Just one more point on that. You know, we are seeing, if we look across different markets, We have seen a meaningful uptick in Asia. We are starting just in the last few weeks to see, you know, more activity out of Europe. You know, certainly you've seen major changes here in North America, but, you know, that's another avenue is to go where the action is. And right now we're redoubling our efforts in the market that are further ahead on the recovery as we look to move that material forward.

Got it. Any pricing pressure on that material, John? You know, either on your existing parts trading or just, you know, presumably a flood of parts out there where, you know, you kind of said you're getting creative and doing different things to market that material. Is pricing eroding in the marketplace?

We've definitely seen pricing at the whole aircraft level, you know, decline. And we've seen some trades out there at, you know, meaningful, you know, discounts from where we saw pre-COVID. you know, certain higher dollar LRUs. We've seen a bit of that, and we expect to see that. But nothing, you know, no kind of macro statistics I could give you at this point in terms of values at the part level. Got it. Thanks, guys.

I'll jump back in the queue.

Thank you. Our next question comes from Josh Sullivan of Benchmark. Your line is open. Hey, good afternoon, John and Sean. Hi, Josh. Just on the cargo business, how sustainable is the current strength? You know, maybe if you could just talk about what the pipeline or lead times look like for cargo conversions.

Yeah, I mean, obviously there's a lot of, you know, action out there in that market. And, you know, you certainly have the traditional cargo carriers, and we talk about our focus on it, You know, we've got sales resources that, you know, previously have been covering, you know, dozens of commercial passenger accounts. Obviously, in many cases, their account base is shrunk or is just not as active as it was before, and we're redeploying those resources to focus on the cargo markets. And that's just not parts. That's also heavy maintenance as well. We actually saw our first 747 cargo aircraft in our – Miami maintenance facility. It's the first time we've done work on a 747 in a really long time in that facility. And we just completed one and shipped it off, and we're looking to do more with that particular customer. So it's an area of focus and I think an opportunity for us, again, not just on the maintenance side, but also on the parts side as well.

And then just how is the conversation going with the airlines on their long-term MRO needs? You know, I mean, at one point pre-COVID, you know, the market was very tight for labor, both for you and the airlines internally. But, you know, as far as the MRO outsourcing model, you know, as the airlines restructure, you know, are you having those longer-term conversations about maybe what outsourcing can bring to them?

Yeah. Yes. I would say that that – is a very dynamic environment and definitely tracks with what you see out there in terms of, you know, their maintenance requirements are going to be aligned with the flying that they expect to do. And so, you know, certainly, you know, no one's talking about bringing, at least to my knowledge that we're talking to, no one's talking about bringing work in-house. Everybody's committed to the outsourced model. And, you know, there is a real interest and focus on the part of our customer base of making sure that top-tier providers like AAR are around to service the aircraft when demand recovers. That expectation, I would say, given recent events here in the U.S., it's pushed out to the right versus where I think people were thinking it was going to be a month or six weeks ago. Everybody expects a recovery. Different customers have different expectations of the timeline of that recovery, and they all recognize, though, that they're going to need an outsourced maintenance provider. And keeping our facilities full and running as best they can to make sure that we retain the workforce so that it's ready when they start to need maintenance at a greater scale is also a major focus of theirs. Okay.

And then just one last one, following up on one of Rob's questions on part outs. You know, just with regard to your relationship with, I believe it's Napier Park, you know, are you anticipating the material use of that joint venture, you know, as those parts material become available? And then how large do you think that could potentially get?

That is a great question. We are very excited about the partnership that we have with Napier Park. We've deployed only a fraction of that capital to date, and so there's a great deal of dry powder to go out and look for opportunities. That said, there's still so much moving in the market, it's difficult at this moment to tell what a good deal really is. And so we're paying very close attention to it, but we're also mindful that what we see today may look a lot different in a month, and we're approaching that market for acquisitions that ultimately could go to tear down or short-term lease very cautiously. Thank you. Thanks.

Thank you. Our next question comes from Ken Herbert of Canaccord. Your question, please. Hey, John and Sean. Good afternoon.

Hi, Ken.

Hey, John. I wanted to ask if sitting here today, as you look at your fiscal second and third quarters for the MRO business, Can you provide any quantification or commentary on how your backlog for MRO looks this year, maybe just relative to prior years, specifically for, you know, the second and the third fiscal quarters?

Yeah. The backlog's less than it was, you know, call a year ago. We – Again, not to repeat, but we're encouraged by the dialogue that we're having from our customers in as much as there's going to be less work to go around, but they want to make sure that their top-tier providers, like AAR, get the work so that we can keep our operations running. We have both through – obviously, we closed our facility in Duluth, and we have shrunk our footprint utilization at certain other facilities – and unfortunately had to reduce our workforce, we have sized our MRO operation for a much smaller labor utilization going into this fiscal year than we would have had last fiscal year. And so, you know, against that smaller footprint, as a percentage, we're actually sold out approximately the same percentage that we would in a normal year. It's just on a much lower base.

Got it. And if my calculations are correct, it looks like with the facility closures from a man-hour basis, you've maybe taken your capacity down by somewhere in the 10% to 20% range?

Yeah, closer to the higher end of that range, yeah.

Okay. Okay, very helpful. And can you just remind us the split of your capabilities in MRO between wide-body and narrow-body? You mentioned a 4.7 down at your Miami facility. Sure. And are you seeing any opportunity yet to maybe take share from cargo carriers that historically have sent, you know, the wide-body aircraft for MRO over to, you know, Asian or other lower-cost markets?

That is a dialogue we're having. You know, we, you know, there's certain of our facilities, our facility in Rockford, facility in Miami, for example, that are wide-body facilities, and we have had, you know, interest, And we have an interest in repatriating that work. There's been a dialogue that's out there for a long time, but they're definitely, you know, given the current environment, I'd say renewed interest to bring some of that work back. So no particular, you know, deals in place there yet, but it is a conversation that we're having. The one – just to go back to your previous question, one point I would want to make – Our capacity in the MRO business is driven by the amount of labor available to us, not necessarily our footprint. So even though we've reduced our footprint, to the extent that we have demand and are able to secure labor to support that demand, we could actually see the same level of production off of this reduced footprint as we saw pre-COVID. And, you know, as Sean said, a number of the changes that we've made, like rationalizing our footprint, position us to be more profitable coming out of this once we see demand recur or return.

Okay, that's helpful. And if you look, John, relative to, you know, I know this time is obviously very different, but as you look at the downturn now, there's a lot of speculation that as demand from the airlines, you know, for MRO and parts and services does start to come back, there will be significant, you know, green time availability primarily on engines and other, you know, more capital-intensive assets. How much of a lag do you expect that to be or to create in the recovery? Is it a matter of weeks? Could it be a matter of quarters? I mean, how are you thinking about that as you think about MRO and parts trading and other parts of your business?

Yeah. I would think about it, you know, at most a matter of quarters. But, you know, a lot of the airlines have already started to burn that green time, right? I mean, they're moving engines from, you know, all of them, you know, at least our customers went, you know, very quickly into a cash conservation mode. And so, you know, rather than sending engines to overhaul, they're swapping engines out on parked aircraft, et cetera, to the extent that there's removable LRUs that they can cannibalize. So that's already occurring, you know. In some ways, we think of it the opposite, as there is actually a very significant amount of deferred maintenance that's building out there so that when we see a return to flying, you might actually see a much quicker and more dramatic uptick in parks requirements and maintenance requirements because that green time is being burned as we speak.

Okay. Very helpful. Just one final question. Congratulations on the unison renewal there. As I look at your distribution business, both on the military and the commercial side, with the new contracts you've added in over the last couple of quarters and renewals like this and potential for, you know, obviously you talked about new potential OEM relationships in this climate. Can that business in fiscal 21 be flat relative to fiscal 20, or can you just give any more sort of cover around expectations for that business?

We expect the government half of that business to be up in fiscal 20, even with the new additions. You know, depending on the timing, I would still say the commercial portion of that business, even with new wins, there would likely not be enough net new revenue to get the commercial business flat. Yeah.

Okay. That's helpful. All right. Well, thank you very much. I'll pass it back there. Thanks. Thank you. Our next question comes from Joseph Denardi of Stiefel. Your line is open.

Hey, John, just along the lines of the prior question, if it takes airlines until 2023 to get back to pre-COVID levels of flying and revenue, perhaps, do you get back there before them, like the same time or after?

I think it depends on how ultimately – the fleet shakes out. So to the extent that, you know, you have more retirements and, you know, and fleets that, you know, see more new aircraft deliveries and more retirements, you know, we could lag to the extent that you see, you know, airlines recover and either defer or cancel new aircraft deliveries. And they've built up, as I said before, a pretty deferred, a pretty significant amount of deferred maintenance you could see an increase well before.

Got it. And when you look across your exposure to aircraft type kind of across the business, obviously there are aircraft types being exited in the U.S. pretty quickly. When you look at what's being retired, are there any surprises? And do inventory levels on the balance sheet reflect some of those risks currently?

Yeah, first of all, no surprises. As a matter of fact, one of the larger ones, American, that was announced many months ago, and it's expanded a little bit, but that was kind of already out there. So no surprises. And certainly, whether it's the 747, you've seen a lot more retirements, obviously, in the wide body, 777s, et cetera. That's less significant to us. So You know, not as concerned about that. And then you've got, you know, MD-80 or MD-80, MD-90s that have been retired. You know, again, no surprises there. So I think so far we're not seeing – or what we're seeing is tracking with what we would expect. And, again, you know, we're very eager, based on particularly the engine support contracts we have with certain shops, to get our hands on material that previously, prior to COVID – would not have been available to us so we can support demand. And albeit the overall demand will be depressed, but we expect to be able to support a greater percentage of that demand as things recover. Got it. Thank you very much.

Thank you. Our next question comes from Robert Spengard of Credit Suisse. Your line is open.

Hey, just a follow-up to Joe's question there. When I look at the 600-plus million inventories on the books here, what you're saying, John, is not a rather insignificant piece of that would be the REDD programs. When I say REDD, I'm talking about some of the programs you just mentioned. So anything with four engines and, you know, MV80s, 90s, 757s.

Yeah, it's a – Correct. The wide-body exposure is very limited. And we actually, in the quarter, we wrote down our positions on the MD-8090. We wrote those positions off. There was some ATR material that we wrote off as well. So anything truly red, we've already taken action on.

Just curious, what do you think of something like these 777s that came out of Delta that are 10 years old? I mean, what's going to happen to airplanes like that? I understand in that specific case, they own them, they'll have to release them, but Is there going to be a market for something like that, at least on a positive basis?

Yeah, I mean, there could be. You know, I think about, I don't know, five or six years ago when, you know, the 767 was dead and we couldn't give away ADC-2 material, and then all of a sudden Amazon started flying and it became one of the hottest, you know, asset types around. There's no question. I mean, that's a great aircraft, and, you know, You know, it's hard to predict where they might find a home, but, you know, we certainly would – yes, it's hard to predict where they'd find a home, but we certainly would expect, you know, use for an aircraft of that type.

Okay. And then I just – Sean, I have one for you, and it touches on some of the things that have already been discussed. But in looking at the cash flow in the quarter, some of the working capital accounts moved differently than I might have expected, specifically receivables and payables. And then more, you know, the other thing I wanted to ask you about this is how do we think about break-even operating cash flow? What level of revenue supports a break-even operating cash flow?

Yeah, on the first part, you know, in terms of the, you know, balance sheet and the network and capital items in the quarter, you know, accounts receivable, given the decline in the top line, you know, we were able to work that down, you know, pretty significantly and have it be a big provider of cash. So I'd say some of that was in line with just activity declining and not kind of new AR being put in. They were able to work down in the quarter. And then on accounts payable, I'd say in a similar way, you know, there was a lot less new purchasing activity because we tried to really, you know, focus on cash flow generation. So this was taking, you know, things that weren't aged, but the payables that were coming due and managing them at the end of the fiscal year. So that's the two biggest. And then on contract assets, as the activity in the hangers comes down, that kind of comes down in line with some of those activity, which is a net provider of cash because of that dynamic. In terms of kind of where does the top line need to be in terms of break-even, you know, For us, kind of not giving guidance on that, but when we think about where the balance sheet is and the amount of inventory we have and focus on turning the inventory into cash, I'd say there's not a kind of bright line of where sales for the whole company needs to be. as long as we can kind of continue to focus on inventory and limit, you know, new buys. Caveat being that as we take advantage of our relative position of strength for things like Unison and other items that come up, you know, we're going to want to put some capital to work on new positions to expand our market share in this period of time.

Okay. All right. Thanks very much, Sean.

Thank you. Next question comes from Michael Ciaramoli of SunTrust.

Your line is open. Hey, thanks for the follow-up. Sean, just to look at – I know you're not giving guidance again, but how are you guys thinking about the level of adjustments, you know, or charges on a go-forward basis? You know, anything that we should expect in the coming quarters, whether it's the ongoing facility severance – Obviously, hard to predict the customer contract and customer bankruptcies, but just trying to get a sense of what we should expect here in terms of any non-operational or non-repeatable charges.

Yeah, good question. You know, and we'll kind of stay away from, you know, forecasting or guiding on that. But there are activities that continue to take place in Q1. You know, one, composites. We included it in the AK I mentioned previously. That would be, you know, about 20 million charges. So stay with it to best return that business. And then we expect there's other kind of, you know, activities, whether it be, you know, headcount or facility activities. and then we're reviewing the portfolio on some of these contracts, but I can't say today what that would look like.

Okay.

Should we expect that? Sorry, I would just add that, you know, we're very focused on any action that we take that results in a one-time event, that, you know, that action is going to have a meaningful improvement on the profitability of the company going forward.

Got it. Should we think about, you know, sequentially, obviously, tough environment, but given some of the cost actions, do gross margins improve sequentially? I mean, it's going to be a lower, you know, volume quarter, but how should we think about maybe the gross margin profile here?

I would say that, you know, over time it will improve, but I would not expect sequential improvement. And, you know, again, the reason we're not giving guidance is because we are in such a dynamic environment right now.

Yeah, totally understand.

Got it. Thanks, guys.

Thank you. At this time, I'd like to turn the call back over to management for any closing remarks.

Great. Well, thank you. Thank you, everybody, for the time and interest today. We really appreciate it, and we hope everyone stays safe out there, and we look forward to talking about our Q1 results in 90 days. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.