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AAR Corp (NYSE:AIR)
Q3 2020 Earnings Call
Mar 24, 2020, 4:45 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, ladies and gentlemen and welcome to AAR's Fiscal 2020 Third Quarter Earnings Call. We are joined today by John Holmes, President and Chief Executive Officer and Sean Gillen, 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 factors sections of the company's Form 10-K for the fiscal year ended May 31st, 2019 and Form 10-Q for the fiscal quarter-ended February 29th, 2020. In providing these forward-looking statements, the company assumes no obligation to provide updates to reflect future circumstances or unanticipated events. At this time, I would like to turn the call over to AAR's President and CEO, John Holmes, you may begin.

John M. Holmes -- President and Chief Executive Officer

Great, thank you very much and good afternoon everyone. I really appreciate you all joining us today to discuss our Q3 FY '20 results. Before I get into the details of the quarter, I'd like to make some comments regarding COVID-19. First, our thoughts are with all of those who have been directly impacted and our appreciation goes out to the healthcare workers around the world who are fighting the front lines on this. As you know, this is an unprecedented situation for the global aviation industry. AAR enters this uncertain period from a position of strength. We have a diverse business mix with approximately 35% of sales from government customers and meaningful commercial sales to cargo carriers. We also have a strong balance sheet with less than 1 times net leverage, significant liquidity, and strong customer relationships. That said, we expect a sizable impact to our commercial airline business as a result of the decrease in commercial air traffic. In order to proactively address the anticipated impact of COVID-19, we are taking steps to ensure that costs remain aligned with the decreasing demand. These steps include a hiring freeze, reducing or eliminating all non-essential spend, reducing executive compensation, furloughs, and unfortunately, reductions in our workforce. That said, we remain prepared to take additional action as warranted to respond to the evolving business environment.

With respect to potential government assistance, I have been in direct contact with members of both the House and the Senate as well as the administration regarding potential support not just for the airlines, but also for the broader aviation industry. As you know, we have worked diligently over the last several quarters to enhance our recruiting efforts, develop training programs, and partner with various schools to create a pipeline for our technicians. Given our focus and success in building and retaining a skilled workforce, we are particularly supportive of all government measures aimed at preserving jobs. The safety and health of our people as well as our customers and vendors is a top priority. We are closely following CDC guidelines and have enacted remote working, social distancing, and related business continuity plans across all of our offices and facilities. These measures, combined with the overall business climate create a great deal of uncertainty and stress for our people and I really want to take this opportunity to thank the employees at AAR for their hard work, dedication, and flexibility as we go through this difficult time. I'm very proud to be part of the best team in aviation.

Turning to our results, we had a record third quarter and I'm pleased with the overall performance. Sales grew 4% from $530 million to $553 million and our adjusted diluted earnings per share from continuing operations increased from $0.62 per share to $0.67 per share. These strong results were driven by continued exceptional performance from our government programs, parts supply, and MRO activities. In the quarter, we announced several new business wins, which demonstrate that AAR continues to be the partner of choice in the aviation services industry. Specifically, we announced plans to expand our airframe maintenance services with Air Canada to cover its A330 fleet. Additionally, AeroControlex, the large manufacturer of critical components to the aviation industry selected AAR to be its exclusive global distributor for the APU, lube, pump product line. We have strong aftermarket expertise in these particular products and are already seeing results from this significant growth opportunity. Finally, we secured a $90 million sole-source IDIQ contract with the Defense Logistics Agency with specialized shipping and storage containers as well as accessories. As described in the release, there are several restructuring actions that we have taken and will take to continue to improve the performance and strength of AAR. As we have previously discussed, we have seen increased cost in certain commercial programs contracts, which were adversely impacting our financial results. We have taken decisive action to exit one contract and restructure two others, which will allow us to free up capital, improve cash flow, and increase margins. These actions resulted in a one-time predominantly non-cash charge of $24.7 million. We have also made the decision to pursue several additional restructuring actions in our fiscal Q4, which involve consolidating facilities to further reduce costs. Before turning over to Sean, I am pleased to share that subsequent to the quarter-end, we completed the sale of our final contract within the COCO Airlift business. As previously discussed, this completes the exit of that business as part of our strategic shift and we are pleased to have that element of our plan complete. With that, I'll turn it over to Sean, our CFO.

Sean Gillen -- Vice President and Chief Financial Officer

Thanks, John. Our sales in the quarter of $553.1 million were up 4.5% or $23.6 million year-over-year. This included a $33 million or 6.6% increase in Aviation Services revenues primarily driven by execution on government contract, which represent approximately 35% of our revenue improvement in MRO volumes and strong demand in our parts supply activities also contributed to the increase. As John mentioned, in our commercial programs business, we terminated one contract and restructured two other contracts during the quarter. These actions resulted in a one-time predominantly non-cash charge of $24.7 million, which shows up in the P&L as a reduction in revenue of $9.8 million and the establishment of forward loss reserves and other related charges in cost of sales of $14.9 [Phonetic] million. Aviation Services gross profit decreased $16.5 million, which was driven by the one-time $24.7 million charge. Excluding this charge, our profit would have increased by $8 million. Each of government programs MRO and parts supplies gross profit increased year-over-year. Gross profit within Expeditionary Services decreased $3.5 million. While we had expected a recovery in this segment this quarter, we continued to experience a delay in a large contract award and certain operational challenges. We are taking restructuring actions in Q4 to reduce fixed costs and overhead. Within Expeditionary Services, we will consolidate facilities, which will improve production efficiencies, eliminate excess capacity, and significantly decrease our overhead and fixed costs. We expect these restructuring actions along with our current backlog to result in improved performance going forward.

Additionally, as John discussed in the fourth quarter, we have initiated cost reduction actions in light of COVID-19, which include a hiring freeze, reducing or eliminating all non-essential spend, reducing executive compensation, furloughs, and reductions in force. In total, we expect the facilities consolidation and COVID-19 related steps to result in one-time costs of approximately $15 million to $20 million pre-tax in the fourth quarter with the payback on these actions realized within one year. In the quarter, SG&A expenses were 10.5% of sales versus 10.3% in the prior period with the increase largely driven by investigation and compliance-related costs. Excluding investigation and severance costs from both periods, SG&A would have been 9.9% of sales in the current quarter compared to 10.1% in the prior year quarter. Net interest expense was $2.3 million compared to $2.4 million last year due to lower borrowings in the current year partially offset by higher rates. During the quarter, our cash flow provided from operating activities from continuing operations was $9.7 million. We continue to invest in inventory to support our parts supply activities. Additionally, as we performed under a certain government program contract that paid in advance last year, we significantly reduced our deferred revenue on the program, which resulted in less cash flows in the prior year period. During the quarter, we returned $2.6 million to shareholders via a dividend of $0.075 per share.

Our balance sheet remains strong with net debt at $171.1 million and net leverage a 0.9 times. Earlier this year, we upsized our revolver by $100 million to $600 million and extended the maturity to September 2024. Our only other maturity is a $23 million term loan due November 2021. As of the end of the quarter, we had total liquidity of $432 million, which included unrestricted cash of $37 million and revolver availability of $395 million. In addition, we had net capacity available under our accounts receivable facility of $92 million [Phonetic]. Thank you for your attention and I will now turn the call back over to John.

John M. Holmes -- President and Chief Executive Officer

Great, thank you, Sean. While we are pleased with our Q3 and year-to-date results, which have tracked ahead of our previously raised guidance, due to the effects of COVID-19 on the commercial airline market, we believe it is prudent to withdraw our fiscal year 2020 guidance at this time. There's no question that COVID-19 will have a meaningful impact on our commercial airline business. That said, volumes from our government customers are strong and are expected to continue to grow and we have a substantial cargo business, which we see potentially expanding in this environment. As for airlines, air travel will return and grow and aircraft will return to service and demand for aftermarket parts and services will be required.

On that note, we believe there will be opportunities for AAR as capital constraints combined with low fuel prices will likely cause airlines to cancel orders for new aircraft and possibly extend the utilization of existing aircraft. Additionally, there will be greater demand for used material as airlines look to save money using aftermarket parts and we, as the largest aftermarket parts supplier in the world, will benefit from increased supply as aircrafts are retired. Moreover, we believe the competition in the aftermarket which had grown in recent years due to the length of the up cycle will decrease as our competitors struggle to survive or increasingly focus on their core activities. I want to reiterate that AAR is in a strong position. We are diversified across end markets and geographies and we have an exceptional balance sheet. I joined AAR just before 9/11 and I've seen what this company can do in times of adversity and we are in even better position today heading into this event. I'm proud to be part of such an amazing team and I am confident that we will emerge even stronger. With that, I'll turn it over to the operator for questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from the line of Robert Spingarn.

Robert Spingarn -- Credit Suisse -- Analyst

Good afternoon. Hey, Rob. John and Sean, obviously this is a very challenging time, so, of course, we wish you the best as you work through this. I wanted to start by asking you if there is any way to frame maybe perhaps on what you've seen so far through March or what you're hearing from your customers and based on these fairly heavy declines in capacity that have started, if you we have some sense for what the ASM decline looks like and how that relates to your business or the various businesses. Is there any algorithm that we can come up with?

John M. Holmes -- President and Chief Executive Officer

Well, not sure if there is an algorithm, but let me try to take it piece by piece across the company. As we mentioned on the government side in the past quarter, in the third quarter, we saw significant growth on the government side and at this point, we see that continuing or we see the government business remaining strong and we expect continued growth there. Cargo as well, cargo through contracts that we have in our parts businesses to supply engine providers, our engine overall providers with parts for cargo customers as well as some activity in the MRO business. We expect the cargo business to hold up and potentially expand as I mentioned. In terms of airline customers and MRO, we are in constant contact with all of our major customers and this is a very dynamic environment and really does change daily. Right now, we have a fair amount of work in the hangars. They're largely full, but we anticipate a meaningful decline in that work as we head toward the summer. We're getting different information out of different customers at this time in terms of the schedules that they are putting together. The one encouraging part in all of that is that we for many of our MRO customers are the main maintenance provider and they recognize the importance of keeping solid lines of work with companies like us and us in particular and the message has been we will do everything we can to keep you full. Now that said, we are expecting a meaningful decline in maintenance activity across the facilities as we head into the summer.

And then in terms of the airline parts businesses, both new or part sales both new and used, we would suggest that those -- it's early to tell and the business actually has been holding up, up until just the last few days, we did see some decline out of Asia in the third quarter and that's continued but the businesses holding up [Phonetic], but we have seen a decline just in the last few days and we are anticipating that that business tracks -- the parts business tracks with -- parts business and commercial PBH business tracks with ASMs.

Robert Spingarn -- Credit Suisse -- Analyst

Okay, could you just refresh us on the percentage of the business that is cargo I guess of the overall top line.

John M. Holmes -- President and Chief Executive Officer

Yeah, it's not something we typically put out, but -- and it fluctuates, but typically we see it between 10% and 15% of the commercial business.

Robert Spingarn -- Credit Suisse -- Analyst

Of the commercial business. Okay and the other thing I wanted to ask you, as we think about all these various pressures is how would you describe your cost structure. I don't know if this is for you or if it's for Sean, but maybe the right way to ask it is your fixed versus variable cost given the labor intensity at least part of your business?

John M. Holmes -- President and Chief Executive Officer

Yeah, given the nature of our business, you think about most of our costs is variable because if you think about the parts supply activities, our cost of sales is obviously the inventory that we procure that we either have on the shelf or we buy in the market and the other part of it are shipping and sales, right. So it's really variable costs associated with activity. Where you have some greater fixed cost is on the infrastructure to support -- obviously the hangers and the MROs. Again, a lot of the labor there is more variable in nature in terms of contracts and the people that support the activity and then in commercial programs, some of the infrastructure to support the supply chain has a more fixed nature to it. So I think we have a highly variable cost structure across the whole company. There are pockets where it's a little bit more variable part supply and some fixed costs in the hangars and other areas.

Robert Spingarn -- Credit Suisse -- Analyst

Okay and then just the last one for me is how we should think about working capital trends from here. You obviously have parts inventory given the decline in activity, do you draw that down, do you continue to be active in parts, how do we think about working capital for the next few quarters to the best of your ability, give us some sense.

John M. Holmes -- President and Chief Executive Officer

Yeah, I know and I think as you're indicating there, this is definitely an evolving situation. We're certainly in a mode right now where we are drawing down on existing parts inventories and as we see things settle out and as we see opportunities arise, we would look to potentially make investments, but right now we are very focused on the liquidity required to operate the business and using the the stock that we have to satisfy demand.

Robert Spingarn -- Credit Suisse -- Analyst

Okay, thank you both for the color.

Operator

Our next question comes from the line of Ken Herbert from Canaccord.

Ken Herbert -- Canaccord Genuity -- Analyst

Yeah, hi, good afternoon, John and Sean.

John M. Holmes -- President and Chief Executive Officer

Hi Ken.

Ken Herbert -- Canaccord Genuity -- Analyst

John, I just wanted to first ask about the commercial programs business, I mean you called out obviously one contract you've exited, two you've restructured, how do we think about that business now in terms of what's left and how do you view the risk now that you've taken this action in these businesses and is it pretty well level set moving forward?

John M. Holmes -- President and Chief Executive Officer

So, I feel good about the actions that we took to address those contracts, they had been a headwind for us as we've indicated the last couple of quarters. So, those were in response to restructurings that occurred within our customers and so I'm happy that we were able to take those actions and they will, as we said, they'll provide an improvement in margin and an improvement in cash flow as a result of those actions. In the context though of COVID-19, power by the hour contracts as the name implies are built on flying hours of the airlines and we have seen reductions across all of those fleets hat we support and certain of those contracts have got minimum flight hour protections in there although we're certainly in unchartered waters in terms of how those protections will be enforced and so we're in a dialog with all of our customers about how our program support going forward will look as they assess the impact to their own fleets as a result of COVID-19.

Ken Herbert -- Canaccord Genuity -- Analyst

Okay, that's great. Thank you and if I could, just to follow up on the earlier question, maybe one way just to help us think about this is, as you look across, specifically the parts supply and MRO businesses, obviously the airlines seem to be cutting discretionary spending pretty aggressively. I'm just curious from a timing standpoint, I would imagine you see that impact certainly on the parts trading and purchase distribution fairly soon maybe to your comment earlier, maybe on the MRO side, there is a bit of a lag, but then coming out of this, I would imagine, you'd see it on the trading and distribution side fairly quickly, but maybe can you just talk about how we should think about on those two parts of the business, the MRO and on the parts side, the timing and how this sort of rolls through the organization.

John M. Holmes -- President and Chief Executive Officer

Yeah, on the parts side, I think you have it right. We really just in the last few days have started to see a decline in volume, it was actually holding up fairly well just into the last couple of days and we would expect as airlines ground fleets and look to cannibalize parts from aircraft that are on the ground, we would expect a meaningful decline in those day to day parts activities both in terms of trade -- typically in terms of trading the distribution business that's largely consumables expandable. So that's -- those aren't parts that necessarily that would be cannibalized but as airlines go through what they have on the shelf, we'll see a slowdown and then we could see some replenishment orders there, but I expect overall that volume on the new part side to decrease as well. On the maintenance side, again, those are -- provided the aircraft come back, those are maintenance deferrals and we would be working closely with our customers to make sure that we're in a position to handle the maintenance events when they start to put aircraft back into service and I would expect that activity -- I would expect that activity to pace ahead of a recovery in the parts business.

Ken Herbert -- Canaccord Genuity -- Analyst

Okay, great. And just finally, can you just comment on what you're seeing specifically out of China or maybe Asia. I mean there has been some speculation that parts of the economy there and air travel at least within China seem to be picking up. Are you seeing that with your customers there and how does that look specifically look?

John M. Holmes -- President and Chief Executive Officer

Yeah, great question and the answer is we have in the last few weeks, we have seen some activity particularly out of China. Going into -- about halfway through the third quarter, we started to see a meaningful decline in order volume out of China in particular and a bit less impacted across all of Asia, but in the last two weeks, we have seen some increased activity. As a matter of fact, last week, we received a multi-million dollar purchase order for landing gear from a Chinese carrier and that's a big order in any environment, particularly in this environment. So there definitely are signs of life with that market returning.

Ken Herbert -- Canaccord Genuity -- Analyst

Great, thank you very much and good luck.

John M. Holmes -- President and Chief Executive Officer

Thanks, Ken. [Operator Instructions] Our next question comes from the line of Joseph DeNardi from Stifel.

Joseph DeNardi -- Stifel -- Analyst

Yeah, hey good evening guys. John, can you just quantify a little bit more how much of the business you expect to track with ASMs -- the deviation [Phonetic] parts, is that about $1 billion or so a year run rate?

John M. Holmes -- President and Chief Executive Officer

If we -- we typically don't split out those those elements of the Aviation Services segment, but if you look at Aviation Services is roughly a third, a third, a third; a third MRO, a third parts, and then a third programs and in the programs, it's roughly split between government and commercial. So we would see the commercial power by the hour programs tracking with ASMs and then inside the parts business with the exception of the government portion of that business and the cargo portion of that business, which I would put it a bit more than half, we would see the remaining half of the parts business tracking with ASM.

Joseph DeNardi -- Stifel -- Analyst

Okay and when you say tracking with ASMs, some of the U.S. airlines are talking about 70% to 80% declines the next couple of months, is that the ballpark of what you would expect?

John M. Holmes -- President and Chief Executive Officer

Yes.

Joseph DeNardi -- Stifel -- Analyst

Okay and then on the commercial piece, how much of the commercial business is with foreign airlines versus U.S. airlines between the MRO parts and the PBH.

John M. Holmes -- President and Chief Executive Officer

Yeah, our commercial business is roughly about 40% international. So when we talk about ASMs, I would look -- I would weight [Phonetic] that by geography. So call it 40% international and 60% domestic.

Sean Gillen -- Vice President and Chief Financial Officer

And as you know in the hangars that's five in the U.S., which I think services the domestic narrow-body market, two in Canada, similar dynamic there and then some landing gear facility in Miami and then two component repair facilities in New York and Amsterdam. So within MRO specifically, it's overweight toward the domestic U.S. market and Canada.

John M. Holmes -- President and Chief Executive Officer

Got it, OK and then, Sean, can you just talk about kind of liquidity, how much you think you have access to and when you would look to access some of that?

Sean Gillen -- Vice President and Chief Financial Officer

Yeah, as I mentioned in my script, we have about $435 million of liquidity. The revolver, we upsized back just in the fall. So the maturity isn't till 4.5 years from now in the fall of 2024 and we upsized $100 million to $600 million in total at that time and that -- the available liquidity the company has, we also put in AAR financing program a couple of years ago and there is some availability under that. So in terms of where we sit today on liquidity, I think we feel good. We're obviously contingency planning and in discussions with our banks to make sure that it stays the same, but feel good about the actions that we've taken over the last, call it six months and where we sit today. [Speech Overlap] The actions we're obviously taking both in terms of overhead and fixed costs are all with an eye to improving the cost as well as the cash position of the company.

Joseph DeNardi -- Stifel -- Analyst

Okay, and then John or Sean, can you just kind of frame the cost reduction actions that you put in place, but how much of that was COVID-19 versus the underperforming contracts and then what sort of revenue environment does that assume and when would you maybe look to do more if things get worse?

John M. Holmes -- President and Chief Executive Officer

Yes. So the Q3 charge is the $24.7 million. That's obviously specific to the restructuring actions in the programs. The $15 million to $20 million range estimate we provided for Q4 are for the Q4 actions as the facility actions as well as the people and overhead action. That's split roughly evenly between kind of facility actions and people actions and I would say that that reflects a demand environment with tracks to some of the things we talked about here in terms of activity in the hangars and ASMs should things deteriorate. We're watching the situation closely, it's still relatively early as we mentioned in the script. We would be ready to take additional action if needed.

Joseph DeNardi -- Stifel -- Analyst

Thank you.

Operator

Next question comes from the line of Michael Ciarmoli from SunTrust.

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Hey good evening guys. Thanks for taking the questions here. Maybe John or Sean, just to go back, the two underperforming contracts on the commercial side, can you give us a little background as to what went wrong there, maybe what kind of prevents that from happening going forward. I always thought once you got those contracts locked and loaded, they would be pretty well off and good performing over the life of the program. So can you give us a little background there?

John M. Holmes -- President and Chief Executive Officer

Yeah in both situations you had fleet changes that occurred at the customer that drove a pretty significant difference between what was impacted or what was expected when we signed the contract versus what we actually felt and we've had negotiations with those customers in recent months to try to correct for that and ultimately, we ended up in this issue and where we needed to restructure the contracts and take a charge. That's the element of the customer side of it. On our side, we had a pretty rapid expansion into that business. As you recall, we signed up a lot of contracts with a lot of different operators in a lot of different environments and it was a pretty stretched supply chain and these were some of the earliest agreements that we signed as we got into that business and our our pricing, our operation and the contractual protections that we look for in those agreements evolved over that period of time, but these were one of -- these were earlier earlier agreements in that regard.

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Got it. That's helpful. And maybe that's a good segue, I kind of hate to ask this sobering question, but as you guys look, you have a better view than us. As you look at your customer list specifically carriers on a global basis I mean have you guys done any sort of analysis on bankruptcy analysis or how many of these carriers might be forced to consolidate I mean you just said you had some rapid expansion there. I mean are you looking at customer by customer and seeing who might be at risk here and where some of these long-term contracts might, might not prove to be valid anymore.

John M. Holmes -- President and Chief Executive Officer

I would say we're taking a look at the liquidity position of all of our customers and I wouldn't limit that statement to just our commercial power by the hour contract orders, we're looking across the whole portfolio. Having said that, our largest customers we feel very good about their own financial management and we've got very we got very close relationships with them and are very active dialog with them in terms of our exposure and and their plans. So overall, I feel, good about our AR portfolio. Having said that, we're certainly in an environment where you are going to see some failures and we've done our own analysis on where those may occur and we're going to do everything we can to limit our exposure.

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Got it, got it. If there is a silver lining thinking about parts trading distribution I mean, do you guys still maybe Sean, do you envision sort of a counter-cyclical sort of cash tailwind here. I mean if you guys do in fact liquidate inventory, you might be resizing in the near-term for much lower volumes, I mean, can we expect maybe some improved cash generation if you're clearly not investing on the part side of the business.

Sean Gillen -- Vice President and Chief Financial Officer

Yeah, I think as you mentioned obviously over the last few years in a growth environment where we've not only been outgrowing the industry taking share as part of that. It's been a somewhat capital-intensive business in terms of the inventory and the erodable asset [Phonetic] that we've invested in to support that growth as you sit here today, with the balance sheet we have and the inventory position, to your point, we're obviously very, very focused on turning the inventory position, the investments we've made into cash. So I think you'll see maybe a higher conversion on inventory as you put less on the shelf and monetize what we have. As we've talked about here, I do think that in the environment we're in, that will be what we're driving to and then in terms of some of the other levers on the balance sheet, AR and AP, specifically, we're going to manage both of those given the current environment.

John M. Holmes -- President and Chief Executive Officer

[Speech Overlap] Sorry, Mike, I was going to add that we do expect to see opportunities as a result of this market dislocation and we see opportunities in terms of potential asset acquisition opportunities in terms of potential acquisition and we do see a clearing out to Sean's point of some of the competition that has come into the market both from small players that may exit completely and very large players that may decide they want to focus on other things. So we've been here a long time, we've seen versions of these things before and a big reason why we maintain such a strong balance sheet so that we can come out of situations like this even stronger.

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Yeah, no, I would agree, John, I think that makes a lot of sense. The last one, just on the the parts trading. I mean I generally agree that we might see some older inventory, older planes in service longer, but we still might see a reduced fleet, we could even see older planes be retired and excess parts in the marketplace, which made pressure pricing, do we have to think about the prices of some of the inventory you're carrying and do you guys ultimately view that as a longer-term opportunity. Would you be opportunistic if you see some really attractive parts out there for some of the popular platforms whether they are 320 [Phonetic] or 737, would you go after them if there is a little bit of a near-term dislocation in pricing in the marketplace.

John M. Holmes -- President and Chief Executive Officer

Yeah, yeah, the answer to that is absolutely we want to time that correctly because we're in a mode here where we need to see how things are going to shape up but absolutely and I would mention that we've talked about this for several quarters now, the demand for aftermarket material has far, far exceeded the supply in the last several quarters and so, obviously you're going to have a meaningful decline in demand and an increase in supply, but given our position and given the relationships that we have and the network we have to get our hands on the best material out there, we should be in a position to, even though it might be lower demand fulfill more of it as a percentage and we have been able to in the past as a result of more material coming on the market and that's our job is to make sure that we time that correctly and make the right investments and get our hands on that choice materials you referenced before anyone else.

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Got it. Helpful. I'll jump back in the queue. Good luck here guys.

John M. Holmes -- President and Chief Executive Officer

Thank you.

Operator

Next question comes from the line of Robert Spingarn from Credit Suisse.

Robert Spingarn -- Credit Suisse -- Analyst

Thanks. I wanted to come back in with two things, one, just on the back of Mike's question there. Maybe the opposite take might some models essentially go out of service here, older models that might obsolesce some of the inventory?

John M. Holmes -- President and Chief Executive Officer

Yes, that could happen, that could happen.

Robert Spingarn -- Credit Suisse -- Analyst

And are you exposed anything in particular that would be notable if you had to write that off?

John M. Holmes -- President and Chief Executive Officer

Yeah, I wouldn't state any asset class in particular at this point, but that's certainly something we're paying close attention to and a lot of the inventory that we carry is tied to long-term contracts and again, there was a bow wave of maintenance events that were the demand outstripped the amount of inventory that we could find so even if you do see some early retirement or an overall decrease in demand, we feel pretty good about the inventory position that we've got right now.

Robert Spingarn -- Credit Suisse -- Analyst

Okay and then the other thing I just wanted to go back to and you mentioned this earlier was what a potential spike in aircraft retirements might mean for the business, if you could elaborate on that a little bit and you know how you guys fit into that because I think it's a less discussed area of the business at least recently and then how customer behavior might be changing in terms of acceptance of USM.

John M. Holmes -- President and Chief Executive Officer

Yeah, I think it's important to remember that USM is a lower cost solution and in environments like this where airlines are really managing their costs much more closer than they have been before. You may see a greater adoption of USM and that would be a fortunate development to the extent that we see greater USM on the right platforms become available in the market. So that is a dynamic that we could see play out and we might play out in past with dislocations as well.

Robert Spingarn -- Credit Suisse -- Analyst

Okay, thank you very much.

Operator

Next question comes from the line of Joseph DeNardi from Stifel.

Joseph DeNardi -- Stifel -- Analyst

Yes. Thanks, John. Just on the defense business, it sounds like it's more or less business as usual there. Is that right or are you seeing some degree of labor disruption just results not being able to get where they need to be. Thank you.

John M. Holmes -- President and Chief Executive Officer

Sure. No, it's been, as I mentioned, we had a very good quarter and our defence government programs revenues were up meaningfully in the quarter and so it's largely business as usual. I'd add that the pipeline for us in the government side has continued to grow. Those awards take a long time due to the procurement process as well as the protest process inside of the government, but we've built great franchise, we're able to bid on more contracts than we ever have been before because of our broad-based past performance portfolio and I would expect to continue to see growth there, but it's going to come in chunks as these contracts are awarded over time.

Joseph DeNardi -- Stifel -- Analyst

Thank you.

Operator

Next question comes from the line of Michael Ciarmoli from SunTrust.

Joseph DeNardi -- Stifel -- Analyst

Hey, thanks again for taking this one, John, just to follow-up, you were kind of hitting on it with the USM, is lower cost and you could see greater adoption. What are your thoughts on MRO right now given what you're seeing with the domestic carriers, you guys are usually a lower cost option. Do you think some of your customers reevaluate what they're doing in-house right now or do you think there is more -- they're trying to support their workforce and their employees. How do you think that evolves in the MRO side?

John M. Holmes -- President and Chief Executive Officer

I think you could, I think that's a good point. I think you could see some net new work come onto the market given the environment as airlines look to -- if they are looking to alter a union agreement or another contract that might allow them to outsource work, this would certainly be a backdrop to do that. So we could see net new work on the market. I would also expect that you may see in some of the domestic competitors not make this through. So you could see at least for a period of time, a contraction in the amount of available hangar space and while we're very focused and as I mentioned we've been in a dialog with the government about potential aid to preserve our workforce to the extent that our new mechanics that are on the market, we could be in a position to bring on a workforce to expand capacity to the extent that's necessary, but there are so many moving parts right now, it's difficult to forecast how all that is going to play out and right now we just want to make sure that we've got our cost base right-sized to support the demand that we see over the next few quarters.

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Got it. And what should we be thinking about labor rate. I mean, obviously this is a pretty fluid environment right now, but do we see a quick downtick in labor rates or how do you guys think that plays out.

John M. Holmes -- President and Chief Executive Officer

I think it's, I think it's a little early to speculate on that. I do think that a lot of that does have to do with what the government -- what actions the government takes and what potential aid may be out there to preserve workforce. To the extent that there is not aid available, you may see a supply of labor come out in the market that we haven't seen in several years and that could impact labor rates, but right now it's pretty early to tell.

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

Got it. All right, thanks guys. Helpful.

John M. Holmes -- President and Chief Executive Officer

Thank you.

Operator

Next question comes from the line of Ken Herbert from Canaccord.

Ken Herbert -- Canaccord Genuity -- Analyst

Hey, John, I appreciate the follow-up. In the last couple of quarters, you've talked about PMA specifically as maybe a growth opportunity or area of investment does the recent developments change your thinking on that?

John M. Holmes -- President and Chief Executive Officer

No, not as a long-term strategy. We continue to believe that that as well as the inclusion of all -- a lot of the inclusion of greater intellectual property generally defined in our portfolio whether that's PMAs, DERs [Phonetic] digital et cetera, all of that is part of the long-term strategy. That said, as you can imagine, we are taking a look at all of our investment projects right now and we're going to moderate those or pace those with how we see the demand for the core services unfolding.

Ken Herbert -- Canaccord Genuity -- Analyst

Okay and as we, as we follow sort of the various scenarios on potential bailouts for the airlines and other parts of sort of the ecosystem, are there any specific aspects of that you're watching or that would be particularly helpful for AAR whether it be on the parts supplier the MRO side, I mean, as you watch this development, what would you specifically be are pushing for as part of some sort of bailout package.

John M. Holmes -- President and Chief Executive Officer

Our conversations with the government, again, I've been personally involved in a lot of these over the last several days our point that, a bailout or aid package needs to address more than just the airlines, it needs to address the broader Aviation services industry because companies like ours, particularly around heavy maintenance are a vital link in keeping the aircraft in the United States flying and many airlines have outsourced those activities and they no longer have the capability and given the tightness in the labor that we've seen over the last few years, we want to make sure that to the extent that there is a decrease in demand and technicians are let go from various companies including our hat as other industries recover faster than Aviation might we don't lose those technicians to other other industries and we want to make sure that we preserve that heavy maintenance capability in particular in America. So our conversations have been largely around providing aid to companies like ours either in the form of grants or loans with forgiveness that would be directed toward preserving the workforce.

Ken Herbert -- Canaccord Genuity -- Analyst

Great, thank you very much.

Operator

At this time we have no questions on the phone line.

John M. Holmes -- President and Chief Executive Officer

Okay. Well, again, thank you everybody for your interest and support and we really appreciate the time.

Operator

[Operator Closing Remarks]

Duration: 45 minutes

Call participants:

John M. Holmes -- President and Chief Executive Officer

Sean Gillen -- Vice President and Chief Financial Officer

Robert Spingarn -- Credit Suisse -- Analyst

Ken Herbert -- Canaccord Genuity -- Analyst

Joseph DeNardi -- Stifel -- Analyst

Michael Ciarmoli -- SunTrust Robinson Humphrey -- Analyst

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