AerSale Corp Q3 FY2021 Earnings Call

Good afternoon. I’d like to welcome everyone to AerSale’s third quarter 2021 earnings call. Conducting the call today are; Nick Finazzo, Chief Executive Officer; and Martin Garmendia, Chief Financial Officer. Before we discuss this quarter’s results, we want to remind you that all statements made on this call that do not relate to matters of historical facts, should be considered forward-looking statements within the meaning of the Federal Securities Laws, including statements regarding our current expectations for the business and our financial performance. These statements are neither promises nor guarantees, but involve known and unknown risks, uncertainties, and other important factors that may cause our actual results, performance, or achievements to be materially different from any future results. Important factors that could cause actual results to differ materially from forward-looking statements are discussed in the Risk Factors section of the company’s Annual Report on Form 10-K for the year ended December 31, 2020 filed with the Securities and Exchange Commission on March 16, 2021, and its other filings with the SEC. These filings identify and address other important risks and uncertainties that could cause actual events and results to differ materially from those indicated by the forward-looking statements on this call. We’ll also refer to non-GAAP measures that we view as important in assessing the performance of our business. A reconciliation of those non-GAAP metrics to the nearest GAAP metrics can be found in the earnings presentation materials made available on the Investors section of the AerSale website at ir.aersale.com. With that, I’ll turn the call over to Nick Finazzo.

Thank you, Kristen. Good afternoon to everyone on the line, and thank you for joining our call today. I’ll begin with a brief overview of the quarter, followed by operational updates and progress we're making on our engineered solutions products, AerSafe and AerAware. I’ll then turn the call over to Martin to review the numbers. We produced strong results in the quarter, which was driven by the broad-based success of our 757 program and an increasingly supportive commercial aerospace end market as airline operations begin the process of normalization. Our third quarter revenue was $73.3 million, which included $27.4 million of flight equipment sales, compared to $57.1 million in the prior year, which did not include any flight equipment sales. The increase in flight equipment sales was partially offset by lower leasing revenue, primarily related to an end of lease payment recognized last year. A decline in TechOps revenue on account of lower aircraft storage and related maintenance activities moderated the increase in our asset management solutions revenue to some extent. Demand for passenger to freighter conversions remains strong, and our plans to monetize the remaining Boeing 757 fleet are on track. Adjusted EBITDA in the third quarter of 2021 was $13.9 million or 18.9% of revenues, compared to $25.6 million or 44.8% of revenues in the third quarter of 2020. The company recognized $6.3 million in payroll support program proceeds during the third quarter of 2020, but there were no corresponding proceeds in the third quarter of 2021. Our lower margins this quarter were largely due to the absence of these proceeds, as well as the contribution from the lease return condition payments we received last year. These results are in line with our internal expectations for the year, and we believe we're well positioned to deliver on our value proposition to our customers and shareholders. Turning to segments specifics and beginning with asset management. We sold $27.4 million of flight equipment that included three aircraft and one engine in the quarter. Within our use serviceable material or USM parts business, airframe and engine parts sales were higher than the prior year period. We are on track to monetize the strategic assets we've held as airlines continued to return aircraft into operation in order to keep up with the upswing in air travel. In line with previous quarters this year, our leasing revenue was lower than the prior year period due to the expiration of three Boeing 747 passenger aircraft leases at the end of 2020. In addition, the prior year period benefited from lease return payments that did not recur in 2021. Our aircraft lease fleet currently stands at five aircraft, two passenger and three freighter, all of which continue to perform well. We remain in the market for asset purchases and expect attractive opportunities in 2022 as airlines assess their fleets following more normalized service levels. In our TechOps segment, third-party sales were down 10.9% due to lower volume at our Roswell storage facility, as airlines returned aircraft into operation and due to reduced capacity to perform third-party work at our Goodyear facility. At Goodyear, we took one of our eight hangar bays and associated labor force to support our Boeing 757 cargo conversion line given the strong demand for freighters. As a result, all the value we added through the supply of labor, materials, engines, and landing gear support are rolled into the cost of the aircraft, and the recognition of any built-in margin is deferred until the aircraft is subsequently sold. Despite this margin deferral, our aircraft storage facilities remain at high utilization, and the labor associated with the recommissioning of stored aircraft has consistently been at near capacity since the start of the pandemic. Moving to engineered solutions, we continue to see incremental demand for our existing AerSafe product platforms, which include the Boeing 737 Classic and NG, 767 and 777, and the Airbus A318, 319, 320, and 321 family of aircraft. We are nearing a final FAA certification to receive an AerSafe STC for the 757 platform. AerSafe serves as a fuel tank flammability reduction, otherwise known as the FTFR alternative to a nitrogen alerting system installed by Boeing and Airbus in new aircraft. AerSafe incorporates a military specification reticulated polyurethane foam system that achieves the technical requirements mandated by the FTFR. In addition to the requirements of the FTFR, an airworthiness directive has been issued regarding the fuel quantity indication system in the 757 center fuel tanks with a mandatory compliance date of May 2022 that can be satisfied by the installation of AerSafe. As such, we expect demand for our 757 AerSafe product to accelerate as aircraft operators utilize our cost and time effective solution to comply with these regulatory requirements. We have also continued our work on product development and FAA approval of AerAware, our advanced technology Enhanced Flight Vision System incorporating a military-style Head Wearable Display that allows pilots to see through adverse weather conditions. We are progressing well towards certification, and at this stage, AerSale has successfully integrated the multispectral camera, Head Wearable Display, and other components manufactured by our partner Elbit Systems and its subsidiary Universal Avionics to an AerSale-owned Boeing 737-800 NG prototype aircraft. We are also installing this system into AerSale-owned Boeing 737-700 NG. Concurrent with the Boeing 737 NG platform, we're engineering the integration of the AerAware system into the Airbus A318, 19, 20, and 21 family of aircraft. Due to the complexity of the technology and in part due to labor constraints with our partners, the pacing item for completion of our AerAware STC continues to be software verification and validation, with an expected completion before the end of February 2022. Final FAA approval should be granted shortly thereafter. After three sets of initial flight testing with the FAA, we have been verbally reassured by the FAA that our system is certifiable. Consequently, although we're disappointed with the length of time this has taken, this is not unusual for the approval of groundbreaking advanced technology. We’re highly confident it's not a matter of if, rather it's only a matter of when we will receive an AerAware STC. In the interim, we've been beefing up production capacity at our Miami PMA facility to produce all of the necessary parts to install the Elbit Systems, universal components in a 737 while we have limited visibility on the exact timing of final FAA approval. We're excited by the massive market opportunity of AerAware and its potential to transform our business. We expect AerAware Enhanced Vision Technology to become the gold standard on commercial aircraft, with its ability to improve safety, offer a very attractive return on investment to airlines, and reduce the carbon footprint of flight operations by minimizing flight delays caused by poor weather conditions, airport diversions, and airport traffic congestion. Looking forward, we expect the ongoing recovery in commercial markets to continue, albeit at a mixed pace as the impact of the COVID-19 Delta variant makes the outlook less clear. Our continued opportunities in the freighter markets are increasing, and we're seeing an increase in aircraft reactivations and aircraft made available for sale. We're on track to monetize our Boeing 757 investment through the remainder of 2021 and the first half of 2022. And we expect to benefit from a pickup in MRO volume due to the recommissioning of commercial aircraft, greater demand for USM parts consumption for overhaul activity, and ultimately contributions from our AerAware product launch. In the long-term, AerSale is excellently positioned. We operate a purpose-built, fully-integrated, multi-dimensional adaptive aftermarket aviation model that includes part procurement, flight equipment sales and leasing, MRO, FAA certifications, and aircraft storage and decommissioning. Our unique model enables us to closely monitor the market, capitalize on opportunities, stay ahead of our peers, and drive internal and external value to all our stakeholders. Our model and diversification have demonstrated AerSale’s ability to deliver exceptional results in dynamic and complex circumstances, and is the primary driver of our ability to increase our full-year EBITDA guidance. Importantly, this guidance increase, which Martin will detail in a moment, is despite the aforementioned delay in the AerAware certification and projected sales, which were included in our original forecast for 2021. We have fully mitigated this delay by higher-than-expected margins in our 757 conversion program, where our value add was enhanced by taking advantage of the goods and services incorporated by all of AerSale’s core operating units. Our unique ability to utilize all the value extraction methodologies of our multi-dimensional integrated business model enables AerSale to achieve positive financial results where our competition cannot. Before turning the call over to Martin, I wanted to take a moment to address the numerous investor questions that we've been receiving concerning our ability to redeem warrants that were issued as part of our spec transaction vis-à-vis Cares Act restrictions. AerSale’s determination is that a redemption employing a cashless exchange of warrants or AerSale common stock does not violate the Cares Act. We submitted our position to the Treasury Department and just this past Friday afternoon received confirmation that 'cashless warrant redemption does not appear to be a compliance issue under the act.' As such, AerSale can exercise its right to redeem the warrants at the appropriate time as prescribed in our warrant agreements. I will not be making any further comments or answering any questions on when we will redeem the warrants until we're able to do so. And I have board approval to publicly issue a notice of redemption. So at this time, I'll hand it over to Martin to go over the numbers before taking any questions.

Thanks, Nick. I will start with an overview of our financial performance before ending with an update on our guidance. Our third quarter revenue was $73.3 million, which included $27.4 million of flight equipment sales. Revenue in the third quarter of 2020 was $67.1 million and did not include any flight equipment sales. As a reminder, our business may fluctuate from quarter to quarter and year to year based on flight equipment sales, and therefore it is important to monitor our progress on asset purchases and sales over the long term. Third quarter Asset Management Solutions increased to $48.9 million from $29.7 million in the third quarter of 2020. The improvement was primarily on account of the above-mentioned flight equipment sales. Consumption of used serviceable material or USM parts for maintenance was strong for the quarter as airlines continued to return aircraft into operation against the backdrop of the upswing in air travel. The increase was partially offset by lower leasing revenues due to a lease return payment recognized in the prior year. Looking forward, we expect the ongoing recovery in commercial markets to continue, albeit at a mixed pace as the effects of the COVID-19 Delta variant make the outlook less clear. We are on track to monetize our 757 investment through the remainder of 2021 and the first half of 2022. Third quarter revenue from TechOps was $24.4 million, down from $27.4 million in the third quarter of 2020, primarily due to a shift in resources at our Goodyear facility away from third-party work towards our 757 cargo conversion line, as well as lower aircraft storage and related maintenance activities at our Roswell MRO facility as airlines returned aircraft into operation. We are in a great position to benefit from additional reactivation work, heavy maintenance, and cargo conversions going forward. We expect to benefit from a pickup in MRO volume due to the recommissioning of commercial aircraft, greater demand for USM parts consumption for overhaul activity, and contributions from our innovative AerAware product launch. Third quarter gross margin was 33.6%, compared to 46.4% in the third quarter of 2020. The decline was primarily due to the lease return condition payment recognized in the prior year. Selling, general and administrative expenses, net of payroll support program proceeds were $22.8 million, compared to $13.4 million in the third quarter of 2020. The company incurred $8.7 million of non-cash equity compensation in the third quarter of 2021, with no corresponding equity-based compensation in the third quarter of 2020. We also received $6.3 million in payroll support program proceeds during the third quarter of 2020, and did not receive any payroll support program proceeds in the third quarter of 2021. Income from operations was $1.8 million in the third quarter of 2021, compared to $19.3 million in the third quarter of 2020. Net loss for the third quarter was $1.6 million, while net income was $14.7 million in the third quarter of 2020. AerSale still incurred $8.7 million of non-cash equity-based compensation expenses this quarter, as well as $2.1 million in mark-to-market costs related to our private warrants, for which there were no corresponding expenses in the year-ago quarter. Adjusted net income excluding both of these items was $9.2 million. Diluted earnings per share was a loss of $0.04 for the third quarter of 2021, and it's not comparable to the third quarter of 2020 due to the public listing of AerSale on December 23, 2020. Excluding the impacts of non-cash equity compensation and the mark-to-market on the private warrants, adjusted diluted earnings per share was $0.22 for the quarter of 2021. Third quarter adjusted EBITDA was $13.9 million or 18.9% of revenues, while adjusted EBITDA in the corresponding period in 2020 was $25.6 million or 44.8% of revenue. Adjusted EBITDA benefited from $6.3 million in payroll support program proceeds during the third quarter of 2020, for which there was no corresponding benefit in the third quarter of 2021. Adjusted EBITDA declined from the year-ago period largely because of the absence of the corresponding payroll support program proceeds in the third quarter of 2021, as well as the contributions from the lease return condition payment received last year. Cash flow provided by operating activities was $17.7 million in the third quarter of 2021, compared to cash utilized of $18.3 million in the corresponding prior year period. The main driver of increased cash generation during the quarter was lower net inventory purchases, as well as higher cash collections from accounts receivable and customer deposits. At quarter end, AerSale had approximately $62 million of cash on its balance sheet, and an undrawn revolver of $150 million. We believe that this financial flexibility will allow us to opportunistically execute and fund our asset acquisition and merger and acquisition opportunities going forward. Finally, our guidance update in summary. Our revised guidance calls for revenue of $320 million to $340 million and adjusted EBITDA of $80 million to $90 million in 2021. This guidance is based on an improvement in the AMS segment, ongoing demand for on-airport MRO services, accelerating demand in cargo and e-commerce markets, increased requests for passenger to freighter conversions, and other TechOps products and services. The decrease in revenue guidance is related to the timing of flight equipment sales. However, strong margin performance offset this decline and resulted in higher adjusted EBITDA. The ongoing and continued monetization of the Boeing 757 fleet acquisition is expected to be the main driver of the AMS segment. We continue to expect to sell the majority of the available aircraft in 2021 and the first half of 2022 as a result of strong demand for cargo conversion aircraft. For TechOps, in addition to higher MRO volume from the recommissioning of commercial aircraft, we expect increased contributions from demand for the AerSafe product. In summary, we are satisfied with our performance during the third quarter of 2021. We are increasing our full-year profit guidance, because our profitability is exceeding our forecasts, as we recognize higher margins for our freighter aircraft due to strong customer demand and our value add. We expect a burgeoning recovery in the commercial markets to continue for the foreseeable future, which will support strengthening demand for our products and services.

Thank you. And we will take our first question today from Gautam Khanna with Cowen and Company.

Yes. Thanks guys. Good afternoon.

Good afternoon.

I had a couple of questions. First just on the guidance change, the revenue range and the EBITDA taken up. Could you, is the entire $20 million EBITDA raise related to the monetization of the 757s? And relatedly, the revenue reduction, was that did what you did to prepare for the modernizations? If you can walk me through that?

Yeah. So as Nick noted, part of the reduction in the overall revenues was one. We removed resources at our MRO facilities to focus on the conversion process. So that revenue will be recognized as we monetize on the 757 transaction. In addition, as Nick noted, based on our original projections, we did have areas where we originally included, we had taken those amounts out. So, looking at kind of what we had already deals that were in the overall pipeline. And we did reduce revenue slightly due to the timing of the flight equipment sales. But margins have been so far for sales that we have actually done and that we expect the remaining quarter have been much higher than what we expected. Again, because we have been able to do much more value add by using all four sections of our business.

That makes sense. And could you remind us on how many of the five 757s are remaining to monetize and engines and what the plans are for the ones that may not have a resale? Can you give us an update on where we really have MOUs, et cetera?

Sure we have the 24 actually 26. We parted out two airframes. First, the first two of the remaining 24 aircraft with engines. We have under contract or LOI, 22 of those aircraft. Martin can give you the details on 23.

21.

We have 21 aircraft and three additional ones that we will schedule for spec freighter conversions if we don't find customers for them. However, we will be actively searching for customers. Our expectation is to monetize the entire package. Nothing from the original 24 will be sold off individually. In fact, we have another 25, all of which will also be kept as whole aircraft.

And then could you comment on the acquisition environment for equipment? What are you seeing? What are you betting on? Any way you want to frame it, but what are you seeing out there?

I previously described the acquisition market as an incoming tide, and that tide is still coming in. While we're not experiencing a flood situation yet, we're noticing that almost every week, more aircraft are becoming available at prices that are starting to make sense for us. This is happening because either aircraft are being put on the market or because they've been available for a year and a half without moving, leading to more realistic pricing that reflects the actual market. I believe it's the latter, as more aircraft are being priced realistically since they aren't moving. Gradually, we continue to see more aircraft being brought to market, and we are bidding on and starting to win those bids. Most of the aircraft we see becoming available are stripped of their engines, which are being retained by airlines or primarily leasing companies, while the airframes are sold. Essentially, selling the airframe takes an aircraft out of service, while the engines remain, shifting the cost burden onto them. Although we are still acquiring whole aircraft with engines, the ones that present the best pricing for us tend to be those that are run out or nearly so. The aircraft we are interested in often require significant work to return to service or are valued primarily for parts. We believe we can extract more value from this equipment compared to a pure financial buyer who might purchase an aircraft ready for service and find a lessee without much effort to start generating revenue. For us, it involves utilizing our full capabilities to refurbish those aircraft into whole aircraft or integrate them back into service. This value addition was discussed earlier regarding our 757 transaction. It is our opinion that a company with the infrastructure like AerSale is essential for handling the extensive work required to return these off-lease used aircraft and engines to service. We see this as our competitive advantage in the market. The opportunities for us lie not in newer aircraft that need no repairs but in those that will require attention. There are many financial buyers out there who will acquire such equipment and wait for someone to lease it at any available price, which is more of a financial transaction without the necessity of enhancing the asset's value through labor.

Excellent. So I’ll get back in the queue. Thank you.

Sure.

We have a follow-up from Gautam Khanna with Cowen.

Sorry, I didn't want to monopolize but I was going to ask also, just do you have a placeholder target for what you expect to deploy for equipment buys next year that you could share with us?

Yeah. It's a really hard question to answer. I can only tell you historically, we have deployed significant capital early on in our business $500 million in the first five years of our business. So by comparison, we can move so quickly today and monetizing whatever acquisitions we make. I would expect over the next several years that we can just – we can deploy hundreds of millions. I can't tell you if it's going to be a 100 million a year or greater or less. But based on our prior performance, where we had less infrastructure, we were able to – we were able to on average, deploy 100 million a year on average. So I think it's realistic to assume that we can double that at this time on an annual basis.

Okay. And then on AerAware, so it sounds like, is that do you think it's first half of next year where we'll get approval? You mentioned kind of soon after the – all the testing is done. But I just wonder like how, what is the lag there do you think? Like, how soon could this happen? Do you think it's the June quarter? Do you think it's the September quarter next year? And then on the back of that, any sense for what an initial order might be for the product based on your customer conversations?

I feel hesitant to specify a timeline, but here are our key milestones. We are waiting for our partner to complete the verification and validation of the software. We expect to receive that by the end of February at the latest. Assuming everything goes as planned, we hope to proceed with final flight testing before the software validation is completed. The issuance of the STC will depend on the validation of the software, but the flight testing itself should not be delayed because the system is operational and has been demonstrated to the FAA three times. The software validation is mainly an audit to confirm that all necessary testing has been completed. We are optimistic that the FAA will collaborate with us for final flight testing before February ends. If that occurs, our only remaining task will be the software validation once we obtain certification from Elbit and Universal, which we are working on simultaneously. In the best-case scenario, we could achieve this by March, but more realistically, it may take until the second quarter. I find it hard to believe that it would extend into the third quarter, but that ultimately depends on the FAA. The FAA's attention has been favorable since they are waiting on us. If this level of interest continues, we are hopeful to receive certification by the end of the first quarter or during the second quarter of next year.

Okay. The other question was just on the initial orders that you might receive on the back of that certification. Do you have a sense for how big that might be based on your conversations with the customer?

We've heard several times that the FAA will require airlines to have half of their fleet equipped with the AerAware system before they can use it, which would mean a minimum of half of the existing 737 aircraft fleet. This includes both the 737 NG and 737 Max, and we are working on both. A 250 aircraft order seems reasonable, as that number has already been discussed. We don’t have any specific details on that; our conversations have mainly been with one potential launch customer, but we've also talked to other airlines. If the customer we’ve been communicating with places a shorter order, I would expect it to be around 250 aircraft.

Thank you very much.

You’re welcome.

That will conclude today's question and answer session. I'll turn the conference over to Nick Finazzo for any additional closing remarks.

Thank you all again for your interest in AerSale and for joining our call this afternoon. I look forward to speaking with you again during our fourth quarter earnings call. Have a good evening, everyone.

That will conclude today's conference. Thank you for your participation. You may now disconnect.