VSE Corporation (NASDAQ:VSEC) Q1 2024 Earnings Call Transcript May 11, 2024

VSE Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings, and welcome to the VSE Corporation First Quarter 2024 Results Conference Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Michael Perlman, Vice President, Investor Relations and Treasury. Thank you, Michael. You may begin.

Michael Perlman: Thank you, Devin. Welcome to VSE Corporation's First Quarter 2024 Results Conference Call. We will begin with remarks from John Cuomo, President and CEO. Also, on the call this morning are Steve Griffin, Chief Financial Officer; and Tarang Sharma, VP, Controller and Head of Corporate Development. The presentation we are sharing today is on our website, and we encourage you to follow along accordingly. Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including those described in our periodic reports filed with the SEC.

Except as required by law, we undertake no obligation to update our forward-looking statements. We are using non-GAAP financial measures in our presentation. We are available. The appropriate GAAP financial reconciliations are incorporated into our presentation and posted on our website. All percentages in today's discussion refer to year-over-year progress, except where noted. At the conclusion of our prepared remarks, we will open the line for questions. With that, I would like to turn the call over to John.

John Cuomo: Good morning. Thank you for being a part of today's first quarter conference call. Today, we share not only the exceptional performance of our first quarter, but also the remarkable strides our teams are making in executing our operational and strategic plans. As I mark my fifth year with VSE, it's truly exciting to witness our story and vision, translating into such strong results. Let's begin on Slide 3, where I will provide an update on our Q1 performance. In the first quarter, we delivered company-wide revenue growth of 28%. This included both record revenue and record profitability for our Aviation segment. The strong aviation revenue growth was driven by balanced results from both our distribution and MRO revenue channels.

Distribution revenue growth was driven by expansion of existing OEM partnerships and strong execution of both new and existing programs. MRO revenue growth was driven by market share gains and expanded repair capabilities and product offerings both supported by strong end market activity. The Aviation segment's record profitability and 17% adjusted EBITDA margins was driven by contributions from new distribution programs, MRO market share gains and our new fuel control program. During the quarter, fleet segment revenue was up 5%, driven by increased sales volume from e-commerce customers and fulfillment partners, supported by disciplined volume expansion at our Memphis distribution center and expanded product offerings, supporting new and existing customers within our commercial sales channel.

This growth was partially offset by a decline in revenue from the United States Postal Service, driven by their implementation of a new fleet management information system, which has resulted in a temporary slowdown in maintenance-related activities and, therefore, parts usage. Now let's move to Slide 3, where I will provide an update on our strategic initiatives and program implementation. First, in April, we announced the closing of our previously announced acquisition of Turbine Controls, or TCI, a leading provider of aviation aftermarket maintenance repair and overhaul services, specifically supporting complex engine components and engine and airframe accessories. The acquisition of TCI is a strategic win for VSE and highly complementary to our existing MRO business.

TCI's 45-year track record of excellence in customer service, industry-leading MRO capabilities and focus on OEM partnerships is 100% aligned with VSE's commitment and long-term strategy to provide world-class OEM support. Their partnership with industry-leading Tier 1 OEMs provides both near- and long-term growth opportunities. We welcome them to the VSE family and look forward to immediate contributions from the team. Second, I'd like to provide an update on aviation program execution and recent acquisitions. In the fourth quarter, we announced the expansion of our Private Whitney Canada distribution agreement to now support Europe, Middle East and Africa. The program launch remains on track with the recent opening of a new distribution facility in Hamburg, Germany and the initial shipments to cut to local customers have happened in the first quarter.

Next, the launch of our new fuel control program, also announced in the fourth quarter is outpacing early expectations and is expected to drive incremental margin opportunities. This is a new revenue channel and capability for VSE. The leadership team managing this program continues to deliver outstanding work as they transition this program from Honeywell and work closely with the engine OEMs and aftermarket customers on the program implementation. Additionally, the expansion of our existing Kansas facility will become the future center of excellence for this fuel control program and is on track to be operational before year-end. The integration of Desser Aerospace is in process remains on track to be completed over the next 12 months, and it's expected to drive additional revenue and margin expansion.

In addition to the execution and implementation work above, during the quarter, we were awarded new business by entering a renewal and significant expansion of a 10-year $175 million agreement supporting an engine accessories OEM. Finally, in February, we entered into multiple agreements to sell the Federal and Defense segment assets. This transition work is on schedule to be completed in the second quarter. Before I turn the call over to Steve for an update on our financial performance, I'd like to address our leadership team transition. Steve Griffin, our CFO, will be leaving VSE to pursue an opportunity outside of the aerospace industry. He will remain with the company through the end of the month and then serve as a consultant and adviser to ensure a seamless transition of his responsibilities.

I want to take a moment to express my personal gratitude to Steve. He is a partner to me in every sense of the word during this first transition of this VSE transformation story. His contributions, exceptional leadership, strong business and market expertise have been invaluable to me. It's funny sitting in front of them while I talk about is I wish him his wife and their 3 children all the best as they move to Boston and embark on their next journey. Tarang Sharma, VSE's current Vice President and Controller and Head of Corporate Development, has been appointed interim CFO effective May 27. Tarang joined VSE in 2015, it has been instrumental in all aspects of our business transformation. Tarang has been by my side since day 1 when I joined 5 years ago.

The VSE Board and I have full confidence in Tarang and his ability to lead VSE's financial operations. With that, I now turn the call over to you, Steve, to discuss our financial performance.

Steve Griffin: Thank you, John. Working with you in the VSE leadership team and the support of the partners and shareholders of VSE has been an honor, and I'm extremely proud to have been a part of such a talented team that was able to accomplish this strategic pivot of a 60-year old business. It's a difficult personal decision for me to leave VSE. I'll be joining another public company in the health care industry based in the Boston area to be closer to my family, but I look forward to following the company's future successes, and I'm confident that Tarang, Michael and the entire finance team is ready to support the next phase of growth. John, it's been a real honor being your partner in this transition. Now let's turn to Slides 5 and 6 of the conference call materials, where I'll provide an overview of our first quarter financial performance.

VSE generated $242 million of revenue in the quarter, an increase of 28%, led by an increase in aviation revenues of 43% and fleet revenues of 5%. Adjusted EBITDA of $32 million increased 37% or $9 million compared to the first quarter of 2023. Aviation drove this growth, up $9 million compared to the same period in the prior year. Adjusted net income increased 51% to $14 million and adjusted diluted earnings per share increased 23% to $0.87 per share. Now turning to Slide 7, we'll cover our Aviation segment's first quarter results in more detail. Revenue increased 43% compared to the first quarter of 2023 to a record $162 million. Both distribution and MRO businesses were strong contributors, up 38% and 58%, respectively. The 38% increase in distribution revenue was driven by strong execution of legacy OEM programs, the ramp-up of new OEM programs, including the Pratt EMEA and Pratt Asia Pacific programs and the contributions from the Desser acquisition.

The 58% increase in MRO revenue was driven by the addition of new repair capabilities, market share gains and improved throughput across our MRO facilities and contributions from the Desser acquisition. Excluding recent acquisitions, Aviation segment revenue increased by approximately 20% compared to the prior year. Aviation adjusted EBITDA increased by 46% in the quarter to $28 million, while adjusted EBITDA margins increased by 30 basis points to 17%, both record results. This record profitability level was driven by operating leverage and productivity from new distribution programs, MRO market share gains and the cost savings generated from the fuel control licensing program. Margins were partially offset by increased costs for our new European distribution facility and facility expansions in Kansas, supporting future fuel control program.

For the full year 2024, we are increasing our revenue growth and adjusted EBITDA margin expectations for the Aviation segment. Full year 2024 revenue growth is now expected to be between 34% and 38%, up from 24% to 28%. This higher range reflects the expected contributions from the recent TCI acquisition, which is anticipated to contribute between $55 million and $60 million of revenue in VSE's fiscal year. We are also increasing our 2024 full year adjusted EBITDA margins, which were previously expected to be between 15% and 16% and are now expected to be between 15.5% and 16.5% as we realized stronger than anticipated cost synergies from recent acquisitions, including the fuel control program. Now turning to Slide 8 for our fleet segment's first quarter results.

In the first quarter, fleet segment revenue increased 5% to $79 million, driven by solid growth in e-commerce fulfillment and commercial fleet sales, partially offset by lower USPS revenue. Commercial revenue was $45 million in the first quarter, an increase of 37% compared to the prior year. Commercial revenue now represents 56% of total fleet segment sales as compared to 43% in the prior year period. USPS revenue declined approximately 19% compared to the first quarter of last year, which is included within our other government channel. When we started this year, we anticipated a low double-digit decline in USPS revenue. However, their recent decision to migrate all locations to a new fleet management system in 2024, has resulted in a temporary impact due to lower repair activities at the USPS sites.

Of the approximate 300 vehicle maintenance facilities in the U.S., roughly 100 went live in the new system in the first quarter, and we expect approximately 100 more in each of the next second and third quarters. As fewer transactions and maintenance activities are temporarily occurring at the sites upon go live, we are forecasting lower sales during the second and third quarter with recovery beginning in the fourth quarter. We remain well positioned to support all USPS vehicle types. We have not seen a decline in market share, and we believe this is temporary. This work and therefore, revenue will recover, and we remain committed to supporting all of their vehicles and facilities during this transition and the recovery to come. Moving on to fleet profitability.

Segment adjusted EBITDA decreased 7% to $8 million, driven by the decline in USPS sales volume. Adjusted EBITDA margin was down 130 basis points to 10%, driven by an increased mix of commercial customers. For the full year 2024, we are revising our fleet segment revenue growth to 0% to 5% compared to the prior year. Full year 2024 USPS revenue is now anticipated to be down 30% to 35%, and we expect second and third quarter revenue to be down 40% to 45% year-over-year with recovery beginning in the fourth quarter. This will be offset by a 40% increase in commercial sales for the full year. We are also updating the fleet segment's profitability guidance, providing an adjusted EBITDA margin range of 6% to 8%, driven by the decline in USPS revenue and an increased mix of commercial customers with the second and third quarters towards the lower end of this range.

This year, we will remain focused on driving year-over-year revenue growth as we scale our Memphis e-commerce distribution facility, add new customers to the commercial fleet list and increase our market share and product offerings on the new vehicle platforms being introduced by the USPS while managing through their ERP conversion. Turning to Slide 9. In the first quarter, we used $79 million of operating cash flow, primarily driven by the initial provisioning of inventory, supporting the Pratt & Whitney Canada European Distribution award, the timing of outflows for recent inventory purchases and the effects of the sale of our Federal and Defense segment. Total net debt outstanding at quarter end was $471 million. Pro forma net leverage, which includes the trailing 12-month results from prior acquisitions, was 3.7x.

Following the completion of the TCI acquisition in April, our pro forma net leverage ratio increased to approximately 4.1x. Pro forma net leverage is expected to be below 4x by the end of this year, driven by free cash flow generation in the second half of the year. With that, I will now turn it back over to John.

John Cuomo: Thank you, Steve. I would like to conclude our prepared remarks by reviewing our 2024 priorities on Slide 10. As previously communicated, 2024 is a year of execution. Let's begin with our Aviation segment. First, our Pro Euro program implementation is accelerating, and our new Hamburg, Germany distribution center is open and shipping products. We are preparing for what's next for that facility with additional product lines to be added, beginning with tires from our Desser acquisition in the third quarter of 2024. Second, our primary focus is the launch and transition of our newly acquired fuel controls program, where we became the licensed manufacturer for over 340 unique fuel controls, spanning 120 platforms, serving both the business and general aviation and rotorcraft markets.

This transition is outpacing early expectations and is expected to contribute an additional $7 million of EBITDA this year and $14 million in 2025. And third is the integration of Desser Aerospace. This integration is in process and includes a full system, process, go-to-market and organizational integration. We expect the integration to be completed over the next 12 months. We are also excited to begin planning integration activities for our recently announced TCI acquisition. Moving to our fleet segment. We remain focused on our organic growth and customer diversification strategy and plan to drive commercial growth as we continue to scale our new distribution and e-commerce fulfillment center. Regarding the USPS, we will continue to support both legacy and new vehicles, while we manage this temporary disruption in activity brought on by their new system conversion.

We are and will continue to be ready for their recovery later this year. In summary, we are very proud to report company-wide revenue growth of 28% to start the year. This included both record revenue and record profitability for our Aviation segment. We remain focused on executing our growth and strategic initiatives to support delivering another year of above-market revenue growth and improved profitability within our Aviation segment. We are committed to scaling our commercial fleet business and managing through the near-term and temporary challenges within the USPS. In addition, a key focus for the remainder of the year is strong balance sheet management and generating solid second half of the year free cash flow. And finally, we remain committed to driving our strategic transformation forward.

This includes finalizing the divestiture transitions for the Federal and Defense segment, repositioning our corporate headquarters and evaluating strategic options for the Fleet segment. Thank you again, Steve, and thank you to the amazing VSE team for what they do each day to support all of our stakeholders and for a great start to 2024. Operator, we are now ready for the question-and-answer portion of the call.

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