VSE Corp

NASDAQ:VSEC

Good morning, and welcome to VSE Corporation Fourth Quarter and 2023 Results Conference Call. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Michael Perlman, Vice President and Investor Relations and Treasury. Please go ahead.

Thank you, Megan. Welcome to VSE Corporation's Fourth Quarter 2023 Results Conference Call. Leading the call today are John Cuomo, President and CEO; and Steve Griffin, Chief Financial Officer. 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, which is 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.

Thank you, Michael. Welcome, everyone, and thank you for joining our call today. I am very pleased and proud to speak today to share both the outstanding record business results from 2023 and the significant progress and updates on our business strategy and transformation.Let's start on Slide 3 of our presentation materials. First, last week, we announced an agreement to acquire Turbine Controls or TCI, a leading provider of aviation aftermarket maintenance, repair and overhaul support services, supporting complex engine components as well as engine and airframe accessories. TCI has a strong presence across a large installed base of engine platforms, including those supporting several key next-generation aircraft. The business operates from 2 MRO centers of excellence in Connecticut and Florida, offering engine component repair and accessory capabilities, including rotating and static engine components, reduction, transfer and accessory gearboxes as well as pneumatic hydraulic fuel and oil accessories.This is a very exciting addition to the VSE family. TCI's 45-year history of customer excellence, industry-leading MRO capabilities and OEM partner-focused strategy aligned with VSE's go-to-market value proposition and long-term OEM support strategy. We expect to acquire TCI for a total consideration of $120 million, comprised of $110 million in cash and $10 million of VSE common shares, subject to working capital adjustments. Steve will share additional financial details shortly in his prepared remarks.Next, we completed the sale of substantially all of our federal and defense operating assets. This marks a very important milestone in the execution of VSE's transformation to an industry leader of aftermarket distribution and repair solutions. We are pleased to find a good home for the FDS assets and their team and closed this chapter of our business transformation plan.The divestiture of FDS was completed in February, with 2 separate transactions to 2 different buyers for a total cash consideration of $44 million, which includes a $10 million estimated working capital adjustment. Associated with the sale of FDS, we will wind down the operation of the one remaining noncore FDS facility that was not included in either transaction. We expect to complete all transition work by the end of the second quarter.And finally, as we focus on driving long-term value for our stakeholders, evaluating our portfolio to ensure we are best positioned to execute on our strategic objectives and strengthen our balance sheet, we announced we initiated a process to explore and evaluate strategic alternatives for our fleet segment. We have only just begun this process and plan to provide an update later in the year.I'd like to take a moment to recognize Chad Wheeler, Group President of the Fleet Segment. Chad has been with the business for more than 32 years and will transition from his position as Fleet Segment Group President later this year. Chad has led this business through many industry changes and most recently, our successful customer diversification strategy. I'm appreciative and thankful for his leadership.Let's now move to Slide 4, where I will provide an update on our 2023 performance. 2023 was an outstanding year, supported by new business wins, strategic acquisitions, product and capability additions, record revenue for both our Aviation and Fleet segment and company-wide record profitability. 2023 was a milestone year for our Aviation segment with revenue growth of 33%. Supporting the revenue growth and strong plan ahead were many successes to highlight. We acquired a market-leading technical MRO precision fuel controls early in the year and fully integrated the business before year-end.We completed the acquisition of Desser Aerospace, a global aftermarket solutions provider of specialty distribution and MRO services, and we are already realizing synergies as we prepare for integration this year. We were awarded and launched multiple new distribution awards, including a geographic expansion into Asia Pacific, supporting a marquee OEM partner as well as a new distribution award supporting Europe, Middle East and Africa customers. We acquired the rights to exclusively manufacture and support certain Honeywell fuel control systems, marking a key strategic expansion into OEM licensed manufacturing and we expanded the capabilities and offerings at our MRO shops, driving record revenue across all VSE MRO facilities while improving overall margin rate.Our Fleet Segment also reported record revenue for the full year with a 21% increase in sales, supported by growth in our commercial fleet sales channel, fueled by an expanded product offering to both new and existing customers; the successful launch and scaling of our new Memphis e-commerce center of excellence and distribution center, driving higher volume throughput and establishing our Fleet segment as a key partner and market disruptor in the fast-growing e-commerce automotive aftermarket and continued support with an increased breadth of products to support all vehicle types for the USPS.I'm very proud of the VSE team and how we came together to support our customer and supplier partners, how we executed on our strategy with new business wins and strong program execution, how we integrated acquisitions and brought businesses together, how we continue to build the VSE brand in our markets and how we performed. We have a results-driven culture and broke records in revenue and profit in 2023. I will now turn the call over to Steve for an update on our financial performance.

Thanks, John. Let's turn to Slides 5 and 6 of the conference call materials to provide an overview of our fourth quarter and full year 2023 financial performance. Let's begin with our fourth quarter results. VSE generated $235 million of revenue in the quarter, an increase of 37%, led by Aviation up 43% and Fleet up 26%. Adjusted EBITDA of $31 million increased 46% or $10 million versus the fourth quarter of 2022. Aviation drove $8 million of this growth and Fleet drove $2 million of growth.Adjusted net income increased 62% to $13 million and adjusted diluted earnings per share increased 31% to $0.85 per share. For the full year 2023, we reported $861 million in revenue, up 29% versus 2022, driven by growth in both operating segments, but primarily by a 33% or $136 million increase in our Aviation segment. Consolidated adjusted EBITDA for the year was $114 million, an increase of 45% or $35 million as compared to 2022. Aviation EBITDA grew $35 million, and Fleet grew $3 million, which was slightly offset by $3 million of higher corporate expenses associated with the FDS divestiture. Adjusted net income increased 60% to $47 million and adjusted diluted earnings per share increased 45% to $3.31 per share.Now turning to Slide 7. We'll cover our Aviation segment, fourth quarter and full year results in more detail. Starting with the quarter. Revenue increased 43% versus the fourth quarter of 2022 to a record $154 million. Both distribution and MRO businesses were strong contributors, up 41% and 49%, respectively. Excluding recent acquisitions, the Aviation segment increased 18% as compared to the prior year. Desser Aerospace, which was acquired in the third quarter of 2023, had a strong fourth quarter generating $23 million in sales.Distribution revenue increased by 41%, driven by the ramp-up of new OEM programs, including those recently launched in the Asia Pacific region. The strength of existing program execution, new geographic expansion and contributions from the Desser acquisition have set a strong foundation for success. The recent acquisition of the Honeywell fuel control program did not have a material impact in the quarter, however, remains on track for transition throughout 2024 as VSE captures new margin and repair opportunities from this important product line.MRO revenue increased by 49%, driven by the ramp-up of new programs, market share gains, new repair capabilities, improved throughput in our MRO shops and the addition of Desser. We continue to drive scale on our existing MRO footprint, which has led to strong profitability and margin expansion. Aviation adjusted EBITDA increased by 52% in the quarter to $24 million, while adjusted EBITDA margins increased by 90 basis points to 15.6%. Contributions from new distribution programs, market share gains within MRO, operating leverage and progress on margin improvement initiatives drove the improvement in profitability.Now for the full year 2023, Aviation generated record revenue of $544 million, an increase of 33% year-over-year. Adjusted EBITDA increased 68% to $87 million and adjusted EBITDA margins were up 330 basis points to 16.1%, all record results for the segment. We are reaffirming our expectations for full year 2024 revenue growth of 24% to 28%, driven by strong aviation end markets, recently announced new business awards, additional organic growth opportunities and a full year impact of the Desser acquisition.We expect our 2024 full year adjusted EBITDA margins to be between 15% and 16% as we work through the increased expenses associated with the recently announced Honeywell fuel control program and the build-out of our new European operations. We're excited about the recently announced acquisition of Turbine Control, its growth prospects and strategic alignment with VSE Aviation. We expect TCI to generate approximately $85 million in revenue and $12 million of EBITDA in its full year 2024, of which VSE will recognize a portion in 2024 following the closing of the transaction. VSE will provide an update to our full year revenue and EBITDA guidance following the closing expected in the second quarter.Now turning to Slide 8 for our Fleet segment, fourth quarter and full year results. In the fourth quarter, Fleet segment revenue increased 26% to $82 million, driven by strong growth in e-commerce fulfillment and commercial fleet sales, partially offset by lower USPS revenue. Commercial revenue was $43 million in the fourth quarter, an increase of 72% versus the prior year and a 14% increase as compared to the third quarter of 2023. Commercial revenue now represents 52% of total Fleet segment sales as compared to 38% in the same period in the prior year.This is the first time in our Fleet segment history that our commercial customers have generated more than 50% of our revenue. United States Postal Service revenue declined approximately 3% versus the fourth quarter of last year, which is included within our other government channel. Fleet remains well positioned to support all USPS vehicle types. In line with our remarks at the November Investor Day, we do expect to see declines in revenue as the mix of aftermarket products shifts to support newer vehicles. However, we remain focused on expanding our offerings for the new vehicles as they exit their initial warranty periods in the coming years.Segment adjusted EBITDA increased 24% to $10 million, driven by increased sales volume. Adjusted EBITDA margin was down 20 basis points to 12%, driven by an increased mix of commercial customers. For the full year 2023, the Fleet segment generated record revenue of $317 million, driven by strong growth in e-commerce fulfillment, led by our recently launched Distribution Center of Excellence in Memphis, Tennessee, commercial fleet sales growth and solid contributions from the USPS. Total adjusted EBITDA of $37 million was up 11%. Adjusted EBITDA margins were 11.6%, down 110 basis points versus 2022 driven by customer mix and start-up expenses associated with the launch of our new Memphis facility.As shared last week with our pre release of earnings, we've revised our 2024 Fleet segment revenue growth outlook to 13% to 17%, primarily as a result of lower USPS volume in the first half of 2024, driven by vehicle part replacement mix. We now expect full year USPS revenue to be down 8% to 12% year-over-year and down low double digits in the first half, improving sequentially in the second half of 2024. Full year 2024 segment revenue growth will be driven by higher commercial sales expected to be up between 40% and 50% year-over-year, again after a 45% increase in 2023.Commercial demand continues to be robust, and we remain confident in our ability to scale and optimize our recently launched Memphis distribution facility. In line with these revised forecasts, we also revised expectations for adjusted EBITDA dollar growth to 8% to 12% due to the increased mix of commercial customers. In 2024, our focus will be driving year-over-year growth in revenue and profit as we scale our Memphis distribution facility, add new commercial fleet customers and increase our market share and product offerings on the new vehicle platforms being introduced by the USPS.Turning to Slide 9. In the fourth quarter, we generated $28 million of operating cash flow and $20 million of free cash flow, driven by disciplined cash management and strong operating results. At the end of the fourth quarter, we amended and extended our credit facility, providing for an additional $122 million of capacity and extended the term by one year to October 2026, allowing us flexibility to finance our near-term capital investments, including the first quarter cash outflow for the Pratt & Whitney Canada, European distribution program, Aviation CapEx for MRO expansion and our recently announced TCI acquisition.Total net debt outstanding at year-end was $422 million. Pro forma net leverage, which includes the trailing 12-month results from prior acquisitions was 3.4x, in line with the guidance provided at the November Investor Day. As we move into the first quarter, we expect our pro forma net leverage ratio to increase to approximately 3.8x primarily driven by the first quarter initial provisioning of inventory supporting the recently announced Pratt & Whitney European Distribution Award, timing of outflows for recent inventory purchases and the effects of the sale of our Federal and Defense segment.Following the completion of the TCI acquisition in the second quarter, we anticipate our pro forma net leverage ratio to increase to approximately 4.1x and improved sequentially through the remainder of 2024, and we expect to generate strong second half free cash flow and deliver improved EBITDA from our recently launched programs, capabilities expansions and acquisitions. This strategic acquisition follows our capital allocation framework laid out in November of temporarily increasing net leverage following an acquisition with a path to quickly de-lever by year-end.I'd like to take a moment to provide details associated with the recently announced FDS divestitures. We expect to complete all FDS divestiture transition work by the end of the second quarter. Associated with these transactions, we expect to record onetime transaction expenses between $6 million and $8 million in the first quarter associated with nonrecurring fees and costs in support of the 2 transactions. The company also expects to record $6 million noncash impairment charges related to the asset not included in the sale.Lastly, VSE has announced is considering a corporate restructuring plan and headquarters relocation, which could result in certain adjustments through our consolidated financial statements, ranging between $18 million and $23 million throughout 2024, depending on the resolution of certain contract and leasing agreements. These actions will eliminate unnecessary corporate expenses and streamline our operational footprint. With that, I would now like to turn the call back over to John.

Thank you, Steve. I'd like to conclude our prepared remarks by reviewing our 2024 priorities on Slide 10. 2024 is the year of execution. Let's begin with our Aviation segment. First, our new Hamburg, Germany distribution center is open and shipping product as of January. Our initial focus for that facility is the execution of our Pratt & Whitney Canada program and supporting the Europe, Middle East and Africa customers with products and services under that agreement. We will expand this facility's usage to support other products later in the year.Second is the transition of our newly acquired fuel control systems program, where we became the licensed manufacturer for over 340 unique fuel controls, spanning 120 platforms serving the business in general aviation and rotorcraft markets. And finally, is the integration of the Desser Aerospace acquisition, which includes full system and organizational integration. This project is underway and will continue throughout the year. Our next focus is on the Turbine Controls acquisition. We expect to complete the acquisition in the second quarter and build upon the strong VSE and TCI OEM relationships to drive strong 2024 performance and a combined growth strategy for the business. Moving to our Fleet segment. We remain focused on organic growth and our customer diversification strategy. We plan to drive commercial growth as we continue to scale our new distribution and e-commerce fulfillment center while continuing to support the U.S. Postal Service vehicle fleet transition. As we execute our 2024 operating plans, we remain focused on building upon the financial discipline and successes of last year. We are forecasting another year of above-market growth for both business segments, growing profitably and generating solid free cash flow in the back half of the year.Finally, we expect to continue to make progress on our strategic transformation, including completing the transition of the Federal and Defense segment divestitures, repositioning our Virginia headquarters facility and exploring strategic alternatives for our Fleet segment. I'm so very proud of our 2023 results, all that we accomplished during the first 2 months of this year, the strong operating plan for 2024 and the amazing VSE team that makes it all happen.Operator, we are now ready for the question-and-answer portion of our call.

We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Jeff Van Sinderen with B. Riley.

Good morning, everyone. Just wondering if you could speak a little bit more about the Turbine acquisition. Any more color you can share on the organic growth rates, what drives that, what the margin profiles like EBITDA and then opportunities for synergies? And then what the integration process you think will look like there?

Sure. I'll talk strategically, and then I'll let Steve talk about the financials. What we love about the deal and about the business is we don't plan to integrate the facilities. They have 2 centers of excellence in Connecticut and in Florida, and they're both very, very strong facilities that we plan to keep and operate as is. Where we see the greatest opportunity for synergy is with the OEM partners. This is similar to VSE, a very OEM aligned business. Think of all the major engine OEMs and accessory OEMs, and that's who they're partnering with and supporting. We also see opportunity to expand into more airline direct customers versus supporting the OEM. So that's really the first year is going to be more about sales synergies than I'd say system and process synergies. Steve, do you want to speak a little bit more to the financials and the margin rate?

Yes. I provided some guidance, Jeff. We expect this year to be about $85 million in revenue, $12 million in EBITDA. Obviously, not all of that will be VSE. We'll acquire the business later in the second quarter, that comes out to a mid-teens margin rate. Going to the question around organic growth prospects within the business, I would just highlight this business is very, very focused on commercial engines and if you look at the industry-wide trends, I think commercial engines is where you'll continue to see a lot of organic growth naturally because of both the legacy fleets that are operating towards the end of their life that require more maintenance as well as the new fleets that are coming into the market that require a lot of entry into service issues. And I think we see this business as having strong organic growth prospects.

Okay. Terrific and then if we could turn to Desser for a moment. Maybe if you could just touch on what's left to do on integration there and then more color on what you see as the drivers of growth for Desser and also the APAC expansion.

Sure, so the Desser business was kind of a group of businesses that wasn't fully integrated when we acquired it. So we're integrating each business unit separately. We are well underway, organizational integration is already relatively complete. System integration prep work is done. We have a new e-commerce site that will be up and running for our VSE Aviation business sometime in the second quarter. After that site is up and running, then we'll start migrating one business unit at a time in Desser from a system perspective. As you know, our philosophy is to fully integrate assets and realize synergies and also be able to offer a one go-to-market strategy to the market. Where we see biggest opportunities is probably with the new European distribution center. So I'd say that towards the back end of the year, we'll start to put tires and other products that right now we're only in the U.K. distribution center into the European distribution center, and that will enable us to provide a more seamless transaction path for our European customers.

Okay. Great. Let me say congratulations on strong metrics and the TCI acquisition.

Our next question comes from Josh Sullivan with the Benchmark Company.

Just digging in to Turbine a little bit, is there or are there dominant products or customers that are more than, say, 10% individually?

It depends on how you define customers. So when you look at the OEMs that they're supporting work for, the answer is yes. When you look at engine types and end-user customers, it becomes a nicer, more fragmented operation. Josh, which is a bunch of things that are attractive to us. But part of it is us building balance and diversification in our own VSE aviation business. As we've grown over the last 3 to 4 years, our distribution business and our business and general aviation business have really accelerated that growth. This provides much more commercial content and obviously, it's a 100% MRO business. So the total balance for VSE Aviation is another significant strategic advantage that this business brings to us.

And then maybe one on Desser. What are you seeing in the retread market, just as airlines gear up for summer travel? Any noticeable changes and seasonable trends here geographically?

Not really. We're not seeing any noticeable trends. Most of the U.S. airlines are direct with manufacturers. So we have a lot of more regional airlines and a lot of European airlines that we serve direct. And I wouldn't say we're seeing any major trend shift in 2024 compared to 2023.

And then if I could just sneak in one last one on Fleet. What is the utilization of the Memphis facility look like today? And maybe what does it look like with the '24 guidance?

It's a great question that I don't have a precise metric on. I would tell you that with 2024 and the continued scaling and well above market growth, we won't even be at half capacity.

Yes, I think that's a fair synopsis. I mean we contributed an incremental almost $50 million in the year and I think we referenced last year that, that was be like 20% to 25% utilization. And although we forecasted commercial growth between 40% and 50% this year, that still leaves us with a lot of excess capacity as we look out to '25 and beyond.

Our next question comes from Louie DiPalma with William Blair.

Congrats on closing the federal and defense sales. I know that's been a long time coming.

Thank you. And I agree.

For John, geographic expansion is obviously a big driver for you. You referenced how you had solid contributions from your Asia Pacific expansion. I think Pratt & Whitney Canada was one of your anchored customers in that region. Are you still in the early innings in Asia? And are your other OEM partners looking to also give you distribution business over there?

The answer is yes to both. We're in our early innings outside the U.S. in general. During COVID, when I arrived at the business, we did a complete restructuring. We essentially shut down most of our international operations and they weren't in ideal locations or set up at the right team. So it's much more of a start-up mentality in terms of Asia and Europe today. We do have a few pilot customers. We have other products as well some business in general aviation. Honeywell content, that's more Asia specific as well. We have tires and distribution that we've set up in Australia and have continued growth opportunities there. So we have some near-term opportunities and yes, there's a pipeline of longer-term international focus as well.

Great. And you mentioned how for the Turbine Controls acquisition, how it's involved in several strategic next-gen aircraft platforms. What are some of those platforms?

Yes. I mean it's on the MAX and it's on the Neo, meaning they're supporting the engine types to support both of those narrow bodies. And then I'd say across the board, they've got capabilities to support almost every engine product type in the commercial space. So there are just a few major OEM partners out there, and I'd say their capabilities are able to support all of them, both wide-body and narrow-body. They do a little bit of military work, but it seems to be much more commercially oriented.

Thanks, Steve and another question from a high level, how do you see like Boeing's issues like impacting the aftermarket industry? And related to that, one of the major aftermarket providers has commented that there's rampant price inflation in the industry right now due to heavy demand. Are you also seeing that?

Post COVID, we saw a tremendous amount of price inflation. We still see aftermarket pricing as a lever that many OEMs continue to utilize. I think there's an element of stabilization that we've seen entering 2024 compared to 2023. And I'd say with regard to Boeing, I mean we all want our OEM partners to be successful. It is in all of our best interest. For us, we're serving the aftermarket. The same supply chain that does work on new build and does work on aftermarket. So for us, we're looking more at two trends, I'd say. Number one is our aircraft that plan to be retired, not going to be retired and are there any areas of opportunity for us to capitalize on that and then number two is how is the supply chain impacted? And what impact does that have for us? And how do we find opportunity in those areas. So I'd say that's where we focus.

Great. And one final one that you may not be able to comment on, but what has been the preliminary buyer interest for the Fleet business?

We started an initial process is exactly that. We kicked off 2024 and in 7 weeks, we sold the 2 FDS assets and acquired the TCI business or announced the acquisition of that business. That was all done in 7 weeks, we have not started the strategic review process. We've announced that we've retained adviser and we'll kick off that process and go through a true strategic review over the coming months.

[Operator Instructions]. Our next question comes from Sam [ Streicher ] with Truist Securities.

On for Mike Ciarmoli. I was curious if you guys give me a little bit of an update on the Southwest program, how that's going?

Yes. I think the program is going really well. So we've been in a few years of that product or that service that we've partnered on with Southwest. Really, that's about bringing a service to that specific customer. It also provides an opportunity for our repair shops to continue to support the 737s that are coming out of service with some of the USM that comes out of those in terms of [ vertibles ]. I'd say the program has launched really well and this year was a peak year. I mean we did more work this year than we did in the year before and the fourth quarter was another record quarter for that program. But I'd say it's a great contributor to our business and more than anything. I think it shows the flexibility that we have with some of our key customers to find creative ways to partner with them on a solution that fits for what they need. And that's what we did for Southwest, and we think it's an important service that we offer to them.

Great. Is there any additional detail you guys could give on kind of your de-levering trajectory once you close that TCI in 2Q?

Absolutely. So you heard us reference, we expect to go just over 4x on a net debt-to-EBITDA basis post the acquisition. Really what we look for in the second half of this year is I'll go through a couple of different drivers. First is contributions from growth in EBITDA. So obviously, we've got some top line growth expected as well as some therefore, profitability growth expected as well. The second thing that we expect to do is deliver some strong second half free cash flow. I think we've got a pretty good demonstrated track record of doing that over the last couple of years, and we project that out into the back half of this year. So that puts us in a strong position to be in a good point from a net leverage perspective. The third thing that I would offer is, obviously, as John referenced just a couple of minutes ago, we are going to go through a strategic evaluation associated with the Fleet segment. And I think there is an element around shoring up the balance sheet associated with that. So we'll provide more updates towards the back half of the year once we complete that strategic review.

We have a follow-up question from Louie DiPalma.

Thanks for taking the follow-up. I was wondering, you mentioned in the press release, I believe, a potential $23 million for corporate restructuring. Do you have any sense on what could be the savings in 2025 from that restructuring?

Yes, Louis, we're just kicking off this progress this process at this point. But I would say this is really about eliminating, I'll call it, some excess core costs following the FDS sale, and it's primarily related to facilities expenses. So we don't have anything necessarily that we would share at this point, but I'd say it's more so about eliminating some of that overhead expense that remains behind following the FTS sale. And you've got a range there, but obviously, it comes down to multiple different factors in terms of discussions with some of the contractors and vendors. So we'll provide more updates on specifics around it once we complete the process.

This concludes our question-and-answer session. I would like to turn the conference back over to John Cuomo, President and CEO for any closing remarks.

Thank you. Thanks, everybody, for joining our call today. Very, very thankful and appreciative of the VSE's team, the strong 2023 results that we were able to produce and the outstanding start both strategically and operationally to 2024. Look forward to speaking to you all in May after our first quarter earnings call. Have a great day. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.