AirBoss of America Corp.

Welcome to the Airbus of America third quarter conference call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press star then 1 on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and 0. I would now like to turn the conference over to Grand Schock, Chief Executive Officer. Please go ahead, sir.

Thank you, operator. Good morning, everybody, and thank you for joining us for the Airbus Q3 2021 results conference call. I'm Grand Schock. I'm the Chairman and CEO of Airbus. Here with me today are Chris Fitzsikakis, our President and COO, Frankie Antilli, our CFO, and Chris Figuel, our Executive VP and General Counsel. In terms of an agenda, we will take a few minutes to review some of the operational highlights for the quarter, and then briefly review our financial results before opening the call to questions. Before we begin, I'd like to remind you that today's remarks include non-IFRS measures. Reconciliations between our IFRS and non-IFRS results can be found in our MD&A. Additionally, management's outlook for 21 and beyond, anticipated financial and operating results, plans and objectives, and our answers to your questions may contain forward-looking information within the meaning of the applicable securities laws. In particular, expectations around the impact of the COVID-19 pandemic, potential acquisitions, results of operations and financial condition, and that of our customers and partners are uncertain and subject to change. The forward-looking information represents our expectations as of today and accordingly is subject to change. Such information is based on current assumptions that may not materialize, and it is subject to a number of important risks and uncertainties. Actual results may differ materially, and listeners are cautioned not to place undue reliance on this forward-looking information. A description of the risk that may affect future results is contained in AIRBOS's AIF and MD&A, available on our corporate website and in our filings with the Canadian Securities Administers on CDAR at www.cdar.com. With that, I will now turn this call over to Chris Bitsakakis for our operational review.

Thank you, Grant, and good morning, everyone. I'm happy to report another strong quarter in Q3 2021, including the production and final commencement of shipments of nitrile patient examination gloves for the U.S. Strategic National Stockpile for HHS. This order worth up to $288 million was an enormous undertaking to produce and deliver 18 million boxes of critically important nitrile gloves. West Coast port backlogs resulted in the shifting of $116 million of sales from this order into the fourth quarter. However, despite this delay, we are reiterating our 2021 outlook and expect record results in the fourth quarter. In the process of ramping up this order, working capital requirements increased significantly to fund short-term acquisition costs related to gloves. However, Completion of the delivery of the HHS glove contract and resulting payments will result in the deleveraging of the company in the near term. We therefore expect to enter 2020-2022 in an extremely strong position, just as we entered 2021, with the financial flexibility and expertise to execute on more large-scale contracts and to pursue further M&A to accelerate our growth strategy. In 2021, we have utilized our financial flexibility to accomplish multiple strategic growth initiatives, We completed delivery of our powered air purifying respirators and related peripherals to HHS and then executed on even larger HHS order for nitrile gloves. We completed payments related to the acquisition of full control of the Airbus Defense Group. We acquired B3, giving us full control and protection of its blast gauge technology prior to anticipated sourcing of major government contracts for overpressure protection for soldiers. We invested in the design and development of our Airbus 100 half-mask respirator a more portable alternative to our successful flexor-powered air purifying respirator at a lower price point, having just recently received NIOSH approval for this exciting new product. In Q3, we successfully completed the acquisition of 100% ownership of ACE Elastomer for U.S. $42.5 million, which has propelled Airbus rubber solutions into a market-leading position in color and specialty rubber compounding and expanded our geographic penetration in the U.S., And at Airbus Engineered Products, we have completed our modernization program, having now invested in and installed new technology to improve automation and efficiency. We also were able to increase our quarterly dividends by 43%. Our strategic and careful use of our financial flexibility in 2021 has put us in a position to continue to grow organically and inorganically. And despite the significant investments this year, we will find ourselves with a similarly strong balance sheet position with growth momentum going into 2022. The company's ability to generate cash and utilize that cash to continue to grow is a derivative of the solid operational and tactical execution of detailed growth plans driven by a focus on innovation and diversification as the main driving forces behind both top and bottom line growth. Notably, we introduced the combination of domestic sourcing and advanced buying tactics along with the development of alternative sources to help mitigate the impact of numerous global challenges on our businesses. Despite headwinds such as ongoing global freight, labour and logistics challenges, raw material price escalations and constraints, and the continued impact of the COVID-19 pandemic, we continued to perform well and effectively managed our operations throughout the third quarter. We expect our positive momentum to continue as we round out 2021 and prepare to enter 2022. While we expect the industry headwinds to continue through the remainder of 2021, We have solidified our position this year as a leading supplier of personal protective equipment to the healthcare and survivability sectors, while making investments to position Airbus Defense Group, Airbus Rubber Solutions, and Airbus Engineered Products for strong performance coming out of the pandemic as the economy stabilizes. As it relates to ADG, the segment continued to execute on its growth strategy, including the continued evolution of a full survivability platform, increased penetration of the healthcare sector, increasing defense sales, and reducing cyclicality of orders by expanding our proprietary products. With completion of the HHS nitrile glove order anticipated in Q4, we will have executed successfully on more than half a billion dollars of orders from the U.S. government in 2020 and 2021, cementing our status as a trusted, large-scale supplier of protective equipment for frontline healthcare, defense, and law enforcement personnel, able to deliver high-quality products during the most challenging of supply chain dynamics. We will also have been one of the largest importers of nitrile gloves in the U.S. for several months running. We pursue more large-scale government healthcare PPE contracts and other survivability equipment contracts, as well as domestic and international contracts for supply of CBRN wearables and potential orders for new Husky 2G vehicles and related vehicle sensors and equipment in our record $1 billion-plus sales pipeline over the next 24 months. We remain confident we will win a portion of these. We are also preparing to market our recently approved Airbus 100 half-mask respirator, a product designed to fulfill a gap in PPE for key government agencies. Designed and developed by Airbus in consultation with first responders and healthcare professionals, this new reusable respirator expands our range of certified respiratory protection products for medical, defense, and law enforcement personnel operating high-risk environments. It is designed to provide filtered particulate protection from chem bio-agents and contaminants at a 99.97% level and builds on the success within the healthcare sector of our existing NIOSH approved FlexAir powered air purifying respirator systems. The AirBoss 100 is designed to provide the same level of respiratory protection as the FlexAir PAPR, but a lower price point as a result of a more portable design, not requiring a battery operated blower. This innovative new product will open the aperture of available high level protection for first responders and healthcare workers far beyond what is available to them today. As I noted previously, our sales pipeline only includes active or imminent sales opportunities and excludes the potential completion for the supply of gas masks to the U.S. military, which we are hopeful to compete for and win, as our industry-leading low-burden mask did in recent years in Canada and Australia. Such a contract would be worth upwards of a billion dollars of sales over an extended timeframe. It also excludes large-scale rollout of our blast gauges, which are currently in field testing with the U.S. Army and in competition for the U.S. Special Operations Command. The magnitude and continued increase in sales opportunities compared to previous years gives us optimism for continued growth at ADG in the coming years. Our longer-term priorities include capitalizing on ADG's enhanced scale and capabilities to pursue an array of growth and value creation opportunities in the broader survivability solution segment, serving both defense and first responder and healthcare markets. We're also building a more global approach to sales of our survivability products, including a new team focused on Europe and Asia, most notably India. While in the short to midterm, ADG is anticipated to continue to be our primary driver of profits. We are also expecting improvements in our rubber solutions and engineered product segments, though there's still potential for COVID-19 related weakness, including ongoing supply chain challenges for the remainder of the year. At Airbus Rubber Solutions, we have seen increased top-line growth momentum through margins, though margins were compressed, by the rapid escalation of pandemic-related raw material, freight, and labor challenges, while realizing a marked reduction of government subsidies. We are seeing continued benefits of the sizable capital investments that we made in Airbus rubber solutions, notably in upgraded equipment and growth initiatives, including increasing our compounding capacity in the southeastern U.S. and adding dedicated color and specialty compounding lines along with a new R&D lab at our flagship facility in Kitchener, Ontario. ARS continues to focus on optimizing its equipment capacity, specifically in Scotland Neck, North Carolina, while continuing to optimize the use of the automated small ingredient weighment system in Kitchener, which is running at steady capacity. Despite adding 15% capacity from our organic investments, excluding ACE, we are now running at over 70% of the upsized capacity versus 60% in 2017, before we began the transformation of ARS. This includes approximately two-thirds utilization of our new color line and one-third utilization of our specialty plant hunting line. We also maintain significant capacity for organic growth, including through further automation. The addition of ACE elastomer has significantly accelerated ARS's strategy to expand from traditional black, high-volume product lines into lower-volume, higher-margin color and specialty markets. In addition, the acquisition has expanded ARS's reach into the U.S. South and Midwest with minimal overlap in customer base and presents opportunities for further revenue synergies. ARS recorded strong year-over-year increases in volumes as well as progressive traction this quarter with increases across the vast majority of sectors due to increased momentum at most customers' operations. However, continued significant raw material price increases coupled with international freight constraints proved challenging on the supply chain. This was further challenged by continued labor shortages primarily driven by the pandemic. The company continues to take advantage of its scale and global supply chain management expertise to onboard new customers seeking new suppliers in the current environment to drive volume and growth in its core markets, which will now be expanded into the U.S. South and Midwest by leveraging ACE's geographic footprint. ARS's focus going forward will be on operational excellence and the production of a broad array of compounded products, white and color, in Kitchener. Airbus continues to invest in its R&D expertise and lab capital to support enhanced collaboration with customers and better reflect the company's focus on innovative R&D and proprietary technical solutions. Our longer-term priority for ARS remains to grow the segment by positioning it as a specialty supplier of choice in the North American market, with a growing focus on building defensible leadership positions in selected compound categories. We are currently reviewing potential regional expansion to the West Coast, where we have customers interested in facilitating our entrance. Although still early in the planning phases, Our approach to enter that region may be through acquisition or greenfield or some combination thereof. At Engineered Products, we have continued to focus on our three-part strategy to reduce operating expenses, produce more innovative higher-margin products, and expand into non-automotive sectors. In Q3, we executed on our operational improvement plan, including managing variable costs and focusing on sustaining a stable workforce while weathering the volume volatility in the automotive sector and specifically on our products for SUV, light truck, and minivan platforms. We continue to drive efficiencies in best-in-class automation through the installation of a new molding platform to replace one that is more than 20 years old, which included installation of 22 new injection molding presses in a multi-year investment with the majority being installed in Q3. In Q4, we will be installing our second fully robotic automated work cell, which will help us continue to reduce labor costs in high-volume work cells, a critical requirement to increase our competitiveness with low-cost operations in Asia. By the end of 2021, we expect to have completed the modernization of AEP's asset base to the highest and most efficient standards, resulting in the ability to both increase our capability to produce more sophisticated higher margin products and lower our operating expenses. Leveraging our modernized equipment, our technical team continues to identify opportunities to utilize our new molding platform to produce higher quality, higher margin parts. An example is our new hydraulic bushings and mounts, for NVH products for non-automotive sectors. And our new team of engineers and commercial sales also continue to seek opportunities to develop new products for non-traditional sectors, including potential military use. In addition, the engineered product segment has also continued to sustain the production of certain molded defense products for ADG at its Auburn Hills, Michigan facility. Despite near-term supply chain challenges, our longer-term priority remains to drive improved performance from IEP through a combination of disciplined cost containment, client relationship expansion, new product development, sector diversification, and a much more aggressive stance on the renegotiation of low margin contracts and any contracts that do not allow for frequent raw material escalation clauses. As an organization, our continuing momentum has placed us in a strong financial position and has given us the ability to be aggressive with opportunities that present themselves. While we have a clear strategy to grow organically, historically, we have also undertaken strategic M&A in order to make critical acquisitions, diversify our products and customer base, and penetrate new sectors. We continue to seek ways to leverage our balance sheet strength and accelerate our growth strategy through M&A, as evidenced by a recent acquisition of ACE. Our M&A strategy focuses on targeting additional acquisition opportunities across the enterprise, with a focus on adding products or compounds, advanced technical capabilities, and geographic reach into selected North American and international markets. As it relates to our outlook, our growth is not dependent on M&A. It is difficult to predict the continued normalization of the economy in the near term due to the impact of COVID-19, including global supply chain issues. But as I have stated previously, the outlook remains healthy over the medium term with industry estimates for approximately 4% top line growth over the next five years. We have obviously outperformed the industry over the past number of years, and our aim remains to continue expanding our market share while increasing our margins through a combination of product mix and operational efficiencies, complemented with strategic and disciplined M&A. Our focus remains to cultivate strong internal processes that lead to organic growth and access of market growth, while assessing both tuck-in and transformational acquisitions as we look to leverage our strong balance sheet to accelerate our growth. With that, I will now pass the call over to Frank for the financial review. Frank.

Thank you, Chris, and good morning, everyone. As a reminder, please note all dollar amounts presented are in U.S. dollars except for dividends per share, which are in Canadian dollars. Percentage growth figures are for Q3 2021 versus Q3 2020, unless otherwise noted. Starting from the top, compared to Q3 2020, external net sales decreased 31% to $112 million on a consolidated basis, largely due to ADG's delivery of the FEMA and HHS PAPR contracts in the prior year. These decreases were partially offset by the increased sales at rubber solutions across the majority of customer sectors. Consolidated gross profit decreased 44% with margins declining to approximately 23%, primarily due to product mix in the ADG segment in addition to government-directed subsidies recognized in Q3 2020. Adjusted EBITDA decreased by 63% to 14 million with the declining gross profit impacted by higher administrative costs. Profit and adjusted profit attributable to the owners of the company was just over $6.9 million or $0.24 per diluted share compared to $11.7 million or $0.47 per diluted share in Q3 of 2020. Turning to our individual segments, ADG's net sales decreased 52% to $52 million with the decrease primarily due to the commencement of the large FEMA and HHS PAPR contract in Q3 of 2020, which was partially offset by the continued delivery of the HHS nitrile patient examination gloves in Q3 of 2021. Gross profit at Airbus Defense Group decreased by 39% to $23 million, with the decrease driven by the change in sales previously noted along with the reduction of government-directed wage subsidies compared to the same period in the prior year, partially offset by favorable mix of certain other products. Net sales at our Airbus rubber solutions increased 34% as volumes were up 4.7%, with increases across the vast majority of sectors due to the increased momentum at most customers' operations, despite continuing supply chain challenges related to raw material supply and elevated freight costs. Gross profit at ARS decreased by 12% driven by increased raw materials, labor and logistics costs, and a decrease in government-directed subsidies, partially offset by an increase in non-tolling volumes and managing controllable overhead costs. Net sales at the engineered product segment decreased by 25% to $28 million, due to the lower volumes in the SUV light truck and minivan platforms related to the global electronic chip shortages, combined with raw material shortages, freight and logistics bottlenecks, which continued to challenge production schedules across all OEMs and Tier 1 suppliers. This was partially offset by production of certain molded defense products. Gross profit at AAP decreased by $5.1 million to a loss of $1.3 million. This was primarily a result of lower volumes in part due to the global electronic chip shortages in the automotive sector, combined with increased raw material costs, raw material shortages, in addition to freight and logistics constraints, partially offset by a continued focus on controllable operational cost containment. Free cash flow for the quarter was an outflow of approximately $130 million, with decreased profits, cash used for working capital of $139 million, and tax payments of $1.7 million. The working capital outflow was primarily used to fund inventory and shipping costs to deliver nitrile gloves for HHS and inventory for safety stock at Rubber Solutions. CapEx was $4.7 million in Q3 and has been approximately $13 million in 2021 year to date. Our balance sheet and liquidity is in a strong position to support further M&A or other internal growth investments. Our increased revolving credit availability is now $250 million, up from $150 million, with the accordion of $75 million, up from $50 million. Approximately $200 million was drawn at the end of Q3 to repay prior amortizing term loan and to fund working capital related to the acquisition of nitro glove inventories for HHS. At the end of the quarter, we had net debt of $186 million for a net leverage ratio of 2.17 times EBITDA. We are reaffirming our 2021 guidance ranges for 2021 as provided in our March 16, 2021 news release and reiterated on May 12 and August 10. Operator, that concludes our prepared remarks this morning. We would now like to open the call to questions.

Thank you. We will now begin the question and answer session. To join the question queue, you may press star then one on your telephone keypad. You will hear a tone acknowledging your request. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two. We will pause for a moment as callers join the queue. Our first question is from Yuri Link with Canaccord Genuity. Please go ahead.

Good morning, guys. Good morning. Good morning. Maybe just some updated thoughts on the ACE acquisition, how you're thinking, if you're thinking on revenue synergy potential has changed at all, and if there's any early wins that you can point out there. between cost selling, between the legacy and ACE?

Yeah, I can talk to that, Yuri. We had a fairly, I'd say, conservative view of the revenue synergies when we made the acquisition of ACE. But I can tell you that as we look at it now, we expect to be able to outperform those expectations that we placed on ourselves. We've already had a couple of early wins. We've visited all the key customers. of ACE that currently buy colored material from ACE. We have a couple of cases where some of those customers needed additional capacity. And because we have some open capacity in Kitchener, we were able to fulfill sort of a combination plan between Kitchener and ACE to address those needs. And many of those customers also were buying black rubber from other competitors. and we have entered conversations about increasing the black rubber component based on their strong relationship with ACE. So although this takes a little bit of a leg to get some of these to hit, we have reason to be very optimistic that the ACE acquisition will continue to drive revenue synergies and cost synergies for that matter because our technical team, which is very strong, has been in ACE and has been working with them on technology and efficiency improvements that as a smaller private company they didn't really have access to. So we see this playing out quite nicely as we go forward with this acquisition of ACE.

Does the ability to cross-sell your traditional compounds, the black compounds, how dependent is that on your facility's location vis-à-vis the ACE customer?

Because ACE was located in South Carolina, we have a black rubber mixing plant in Scotland Neck, North Carolina. We're in that same sort of region where we can support their existing clientele with the products out of Scotland Neck. So we think regionally it's going to be a nice overlap because there wasn't hardly any, if any, customer overlap. But because of the strong reputation Ace has had and the many, many years of good performance at these customers, there have been doors open for us that weren't necessarily there before. And the acquisition of Ace by AirPods was received very well by Ace's customers. And because of that, we've started out, I think, quite strong.

That sounds good. Chris, while I have you, Any update on the bid pipeline? I mean, how are you feeling today versus a couple of months ago in terms of your confidence in bringing in an order that might underpin 2022?

Yeah, as we've mentioned before, the bid pipeline, and we define pipeline as opportunities we're either currently negotiating on or have submitted a bid, or it's imminent that we will be submitting a bid And the pipeline has grown significantly. It hasn't gone backwards in any way. And so our optimism related to being able to secure a large portion of what we see ahead of us is quite high.

I'll go back in the queue.

Our next question is from David Ocampo with Cormark Securities. Please go ahead.

Good morning, everyone. Do I see or hear any commentary about the remaining $288 million option for the nitrile gloves? I'm just curious where that stands today, or does that remaining $288 just go back into an RFP process for the government?

Yeah, so we expect that the government will, instead of issuing the option, will have a recompete for a couple of reasons, the main one being that the requirements are larger and um there seems to be some added capacity so we believe that there will be a recompete uh it may be larger but right now our key customers are focusing on other healthcare products and they put that on the back burner and so we are focusing on other opportunities other than the nitroglove option right now but we do expect that to come back and we do expect there to still be significant demand in 2022 for a new competition on gloves, which we should be well positioned for then as well.

And Chris, can you talk about some of those near-term opportunities or is that still early to disclose?

For now, we have not disclosed any of those near-term opportunities publicly, but what we have said is that we are actively in negotiations on multiple opportunities and we feel very optimistic that 2022 will have a lot of momentum going into.

Okay. Just shifting gears here to the automotive side, and that's an area that's pretty notorious for having price decreases every year. But when we look across the board, you know, the inflationary pressures are probably much higher than they've ever been before. We've heard labor increases as high as 10% or 15%, and raw material prices are going through the roof. So have you had any discussions with your customers on potential rate increases or should we think about your older contracts as kind of negative or zero margin business going forward?

So it's kind of a mixed bag there, David. We have some of our customers, let's say we've approached every single customer and we've been successful with multiple customers on adjusting our purchase orders to allow for freight increases, raw material increases, those kinds of things. Of course, there's documentation required, so we've been able to set up a process to pass many of those increases on. The problem is that we have probably between 25 and 30% of our customers that are refusing to negotiate, being very difficult, staying behind the current contracts, and making it extremely difficult for us. So we have ramped up the conversations We are now dealing with a very senior leadership in those particular companies so that they understand that we cannot continue to absorb the raw material and freight increases for them. Having been successful with other customers, we expect them to fall in line as well. We are not complete with those negotiations yet, but we are acting very aggressively and very strongly on insisting that we get that done because we don't see Any slowdown in the inflation, the price of steel and other commodities continue to grow. And so as that happens, we need our partner customers to share that with us. And we've been successful with, I'd say, close to 75% of them, but the other ones not. So we need to drive that even harder here in Q4 and make sure that we enter 2022 without this overhang.

And how are those discussions in your rubber business? Is it better or you don't have 20 or 30% of your customer base refusing any pricing?

So Airbus Rubber Solutions, every single one of our contracts has the ability to pass on raw material and freight economics. So we're less concerned about ARS. The issue with ARS is that there is a timing issue. Traditionally, we were repricing all of our compounds quarterly. But then when the raw material escalation started to happen fast and furious, we went to monthly pricing. But even within that month, we're getting either increases that were not planned or even forced majeures where we're put on allocation on supplier, then we have to reformulate with a more expensive material. And so we're doing all these things, and therefore there's a lag. So as the raw material is going up, going to lag behind a little bit and as the raw material comes back down we'll be able to pick that all up but it'll be out of period okay that's great i'll hop back in the queue thank you our next question is from team james with td securities please go ahead uh thank you good morning everyone

Maybe just sticking with the topic on the cost inflation and AEP in particular, Chris, if we assume for a minute that those remaining 25% to 30% of customers that have not been helpful in negotiations so far, if we assume that there is no further progress, over what period do those contracts actually expire, which would then provide you with a contractual opportunity to either reprice or walk away. I'm just thinking about kind of the natural margin expansion opportunity that that could provide, I assume, as those contracts end. And you can reach new terms or decide the business is an economic and you don't want it.

Yeah, that's a great question, Tim. And in fact, because it's multiple contracts, there's a range. Some of them start to drop off late 2022. The majority are dropping off in 2023 with the first half of 2024 being the stragglers, so to speak. So over the next one to three years, they will all have been finished and they will stop being a drag on our overall profitability. But because we see this inflation continuing, we need to be very, very aggressive to get those customers in line with what we require to keep supplying them, even between now and the next year and the year after.

Okay, great. And then just in general, could you talk about your capital expenditure kind of plans, just some guidelines on what amount it could be for 2022, and then sort of what where what type of investments that you're planning will make in 2022?

Yeah, so right now, year to date, as Frank has mentioned, we've spent about $13 million and we should hit around 15 by the end of the year. We are right this moment. We've just had all of our strategic reviews in each of the business units where they gave us sort of their vision of the next one to three years in terms of their growth and expansion plans. And we have not solidified the capex budget for next year. However, normally we're going to be right around what depreciation is. So we expect to be close to that $15 million. But some of the divisions have some interesting plans that could expand on that if there's good payback.

Okay, that's great. And then maybe one more question just quickly for Frank. To the reference to getting fairly close to break even working capital in terms of cash usage for the year, I think on the second quarter call now, a lot of things have changed since then. Can you give a bit of a sort of an update on where, you know, if we think you can either comment on the fourth quarter specifically or the year as a whole, kind of how working capital should be in terms of a drag or a generator of cash for the year?

Yeah, thanks, Tim. A good question. Essentially, as noted, obviously, Q3, when we flipped into our new facility and quite a bit of working capital was tied up specifically on the inventory for the HHS nitrile gloves. In addition, obviously, there was some AR and investment in some safety stock inventory. We are now seeing the conversion of the remaining portion of the HHS contract converting in Q4 and the cash conversion is starting to come in. So we still anticipate to get close to that break even by year end, deleveraging, and obviously being in a very strong position financially and from a cash flow perspective as we enter 2022. Okay, that's great.

Those are all the questions I had. Thank you very much. Thank you.

Our next question is from Kevin Chung with CIBC. Please go ahead.

Thanks for taking my question here. Maybe just following up on Tim's working capital question, I think in the prepared remarks, I guess the suggestion is your inventory will definitely normalize because you'll have delivered on the HHS glove contract. But in terms of accounts receivable, are there any receivables that bleed in from that contract into 2022 or does that get paid up by year end as well? or your anticipation to get paid up by year-end as well?

Yeah, that's a great question, Kevin. We anticipate, and again, we have very strong payment terms in that regard. We anticipate a very small portion to bleed into 22, and I would suggest it probably be less than 10% of the remaining contract value that would bleed into 22. But the conversion is going according to our plan in Q4, and we anticipate having very little overhang into the next year.

Okay, that's helpful. Maybe if I could turn to ARS, and you noted, Chris, the freight and commodity price pass-through, maybe a little bit of a timing delta, and I appreciate the volatility in those inputs today. If I look at, I don't know what quarter you want to call the rapid pace of inflation picking up, but You know, if I look at maybe some points in 2020, you were, you know, hovering in the high teens of gross margin with an ARS, you know, today around 12%. So if I look at, I don't know, let's call it a six, seven point delta, is there a way to think about how much of that might be structural costs you need to deal with, you know, like higher labor versus maybe transient costs that you'll recover as, you know, as you pointed out, as some of these inflationary pressures either ease or as you get to kind of recoup them? through these contracts?

Sure. I mean, certainly, and particularly in Q3, there were some significant raw material challenges, both from a delivery and from a cost perspective, but also significant labor challenges as well. As most of the regions that we operate within have certain allowances for time off for COVID-19 testing and other things like that. And we've seen, you know, with a lot of government subsidies for people, it's been very difficult to get people to come into work every single day. It's also been very difficult to attract new people. So we've had to make some structural changes on our labor side to make sure that we attract, retain, and reward people with strong attendance. So that certainly, I would call that a structural component that we think we will also be able to build into our pricing going forward. And on the raw material side, we of course are in the process of building that in going forward. So in terms of the actual structural piece of it, I think we'll be able to pass on all those additional costs to our customers through the cost of the product and the pricing that we offer. Because all of our competitors are in exactly the same boat that we are. Everyone is having to address the labor issues. And it's certainly more costly. Everyone is addressing the absenteeism issues, and they're working more overtime. So those, I think, will eventually get passed on. Now, having said that, Q4 has already started to come down a little bit on the labor side. But the raw material side has not continued to – it continues to increase. So we will build all those added costs into our pricing going forward, again, with a little bit of a lag time.

Okay, that's helpful. And then you talked about some of the productive capacity you have within ARS, which I suspect is a real competitive advantage here, just given the supply chain disruptions broadly in your industry. I guess I'm wondering, what's the bottleneck to kind of get that utilization higher? Is it primarily labor and maybe sourcing raw materials? That's the bottleneck? Or is it, you know, you know, getting the right contracts to make sure that customers or that you're not, you know, assuming too much risk given all the volatility and, you know, getting those contracts across the line has been the bottleneck. Just wondering how you see the glide path forward to get utilization rates higher.

Yeah, I mean, we have a very detailed and aggressive plan to continue to grow ARS organically and inorganically, as we mentioned before. In terms of bottlenecks, I'd say for Q3 labor was a real bottleneck. It was extremely difficult to, you know, because you would schedule certain shifts and you wouldn't be able to get them in. So it was a little bit difficult. Having said that, things look like they're starting to improve now in Q4. Raw material, of course, availability was the other bottleneck. So, you know, we would have opportunities for new customers, but we would have to get, you know, new raw material. in that was not necessarily part of our original forecasting. And now, you know, it's months out instead of what it used to be weeks out to get increases in the raw material that you've already had allocated to you. I think both of those issues will come under control. And we're working on several fairly large-sized organic growth opportunities, particularly for Scotland Neck. You know, we installed that new mixing line a year and a half ago. And now we're starting to see the availability of business to fill it as long as we can get the labor in line and the raw material. So we're pretty bullish on being able to continue to grow our capacity that way. Now, of course, there is a timing involved in that. First, you develop the formula. And then you create small samples. The customer tries those samples. Then you do larger samples. And then you get feedback. And then we have our people on their production lines taking notes on what needs to happen, what needs to change. And so that product development cycle takes a little bit of time. But once we launch it, it's a very sticky relationship. As you know, most of our customers have been with us between 10 and 30 years. So once they come on board, they stay on board. So we're going to see a lot of organic growth in ARS. The only bottleneck is a little bit on the labor side and the raw material side. Even there, we're finding ways to mitigate that now.

Okay, that's helpful. I forgot to squeeze one more in here. I appreciate the challenges within engineered products, but I guess if I look at your revenue in the quarter, it was called a flat quarter over quarter, which I would argue outperformed a lot of other auto suppliers. So just wondering... Maybe why you think that was, if there's anything you'd point out as to maybe why you would have outperformed, let's say, production numbers for autos, which I suspect would be the primary driver of sales. And then is there a mixed issue here? Are you winning more non-auto business and that's helping offset maybe some of the weakness on the auto side and it's just kind of washing out as being flat quarter over quarter?

Yeah, thanks, Kevin. Our business at AEP is focused on trucks and SUVs, and that normally is stronger than the small car platforms. And so that may be one of the reasons behind it, but we've not analyzed it specifically, but that would be our first guess.

Okay. I'll leave it there. That's very helpful. Thank you very much for taking my questions. Thank you.

Our next question is from Maggie McDougall with Stifel. Please go ahead. Morning.

Morning.

I'm wondering if you guys could give us a little bit of a preview into how we should be thinking about 2022. I mean, we've talked a lot on the call about various challenges around the supply chain and all kinds of things. which is, of course, very important. But I think probably more important is the progression of things like Blast Gauge, the HHS gown order contract, and the rest of your backlog in healthcare and defense, because the supply chain stuff will eventually get sorted out, and these are the things that are really going to be the drivers of value for shareholders in the future. When we think about Blast Gauge, can you give us an update on how that has progressed, where you view internally the milestones to be, and how we should all be thinking about that opportunity?

Yeah, Maggie, it's Grant. Look, we haven't put out guidance for 22 yet, obviously. Except for when we made these acquisition we we we said that we expected that would contribute about twenty eight percent or so of the growth to rubber solutions the. The blast gauge. Opportunity we expect to get awarded sometime in twenty two but we don't have a. We don't have a date yet on that. So I would push, you know, I wouldn't think we'd have huge last-gauge revenue in 22, more ramping up towards the end of 22 going into subsequent years. As we've mentioned numerous times in the past, we have well in excess of a billion-dollar pipeline And we expect reasonable to good success on that pipeline. And we certainly expect growth to continue in 22 and 23. But we haven't been specific as to guidance yet. We don't even have Our internal budgets approved yet not typically happens in mid-December. So when we have that or when we have firm contracts from the pipeline as opposed to indications, we will announce them if they're material.

Okay, thanks. With regards to milestones on Blast Gauge, this is a new product that's going to be hopefully adopted by the military. Are there progress markers that we should be thinking about outside of formal guidance, just more thinking about progression of that opportunity?

We're working on two specific opportunities with Blast Gauge. One of them has... has had a number of milestones throughout the year where we were required to deliver various stages of final prototypes, for lack of a better word. And the last final one is due to be delivered in December. So assuming that that is and it doesn't require any further tweaking, they should be making a decision within sort of normal government timeframe, which, you know, there has been some stuff in the press fairly recently about complaints that the brain damage caused by recent incidents wasn't measured accurately, so there's increasing political pressure to get moving on this, so we're hopeful it'll happen sooner rather than later, but unfortunately it's a bit beyond our control. It's actually totally beyond our control. So anyway, the last thing due from us to them is in December. So we will deliver on schedule in December to them and they'll evaluate and make a decision after that.

Okay, great. Thanks. And just for clarity, blast cages is not included in your billion dollar backlog because it's not something that you've actually completed an RFP on yet.

No. I mean, it's minor amount is, I mean, we, we, We are not selling blast cages. We do sell, you know, relatively small quantities of them. And anything that, you know, we have got some requirements for next year, but nothing material.

Okay, thanks. And then on the HHS gown contract, which was listed, On the website on Friday, the notice for sole source opportunity, I read here that no more proposals can be entered past November 12th, which is the end of this week. What sort of timeframe are you expecting with regards to a determination by the government on that potential opportunity?

We don't have any more information than was put on their website, Maggie.

Okay. Okay, thanks.

I'll get back in the queue. Our next question is from Ben Jackich with PI Financial. Please go ahead.

Yeah, good morning. I have two questions, you know, maybe for Frank. Just with regards to net debt, If you can just maybe elaborate a little bit how we should think about that until the end of 2022. So I'm assuming there will be a rebound in the fourth quarter after the glove shipment is delivered. You know, is it going to be sort of, you know, like a Q2 level plus, you know, plus what was borrowed to pay for a celestomer or?

Yeah, thanks for that question, Ben. Yeah, we expect the deleveraging profile to put us back into sort of the Q2 level of net debt with the addition, obviously, of ACE. But, you know, we anticipate strong cash flow with a significant deleveraging profile. And, you know, by the end of 2022, again, it's very early, but subject to our working capital requirements, we're going to be in the same healthy position that we've seen sort of earlier this year, both in Q1 and Q2. Oh, that's great.

And then the second question, minor question, with regards to 2021 guidance, you're still keeping, if I'm calculating correctly, about $80 million range on the revenue side. And now we're sort of two months before the end of the year. Is there a reason why it's still at the $80 million? Like what does... 6.30 represent versus 7.10? Like are you keeping some flexibility for last minute orders or?

Yeah, that goes back to our original guidance and that obviously subject to everything that's going on with customers both on the ARS side and the AFP side. You know, That's the range we've given, and we're sticking within that range from previous note. There's nothing built in for cushion, but we wanted to give ourselves that flexibility subject to the volatility in the market as it relates to volumes and sales. But we're still reconfirming our full-year guidance. Gotcha. Okay, thank you. I'll go back in the queue.

This concludes the question and answer session. I would like to turn the conference back over to Grant Shock for any closing remarks.

Thank you, operator, and thank you again to everybody for attending this morning's call. We're all proud of how we've performed this year, and I want to thank employees across the organization for this. We're excited for the future of the company going forward. Until then, we hope you're all keeping safe and well, and we will Talk to you on the next call. Thank you.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.